ECONOMIC AND BUDGET ISSUE BRIEF

Pharmaceutical R&D and the Evolving 

Market for Prescription Drugs

Investment in research and development (R&D) over the 

past several decades has produced a wealth of valuable 

new drug therapies that have made it possible to treat 

major illnesses that were not treated previously or were 

not treated as effectively. As the scope of available drug 

therapies expanded, spending on prescription drugs 

became the fastest-growing category of total spending on 

health care in the United States. Between 1994 and 2004, 

real (inflation-adjusted) spending on prescription drugs 

rose at an average annual rate of 11.1 percent, compared 

with 3.5 percent for hospital care and 4.3 percent for 

physicians’ services. More recently, however, that growth 

has slowed: From 2004 to 2007, drug expenditures grew 

by an average of just 3.2 percent per year, slightly less 

than the rate of growth in overall health care spending. As 

a fraction of total spending on health care, spending on 

prescription drugs rose from 6 percent in 1994 to around 

11 percent in 2004, where it has remained (see Figure 1).

That slowdown in the rate of growth in spending reflects 

changes in both the supply of and the demand for prescription drugs. On the supply side, the patents for many 

top-selling drugs have expired, subjecting them to competition from cheaper generic compounds. The resulting 

decline in spending on those drugs has not been fully 

offset by added spending on new brand-name drugs 

because, at the same time, the rate at which new drugs are 

being introduced has slowed substantially. On the 

demand side, many health plans have sought to control 

the growth in their expenditures by creating stronger 

incentives for their enrollees to choose generic drugs or 

cheaper brand-name drugs.

Decisions regarding pharmaceutical R&D depend largely 

on drug manufacturers’ expectations about future revenues. Expectations about revenues are shaped by the conditions affecting the potential demand for each drug, 

such as the size of its market, its price, and the amount of 

competition expected from other drugs. The greater the 

expected revenue from a prospective new drug, the more 

willing a drugmaker will be to invest to develop it. Those 

decisions will help determine which drug therapies 

become available in the future and thus will affect future 

growth in health care costs. This brief describes the current state of investment in drug R&D and the factors 

that influence it. It also examines how various policy 

options to control the growth in health care costs or to 

expand insurance coverage could affect R&D spending.

Figure 1.

Spending on Prescription Drugs as a 

Percentage of Total Spending on 

Health Services and Supplies, 

1980 to 2007

(Percent)

Source: Congressional Budget Office based on data on spending 

for health services and supplies, as defined in the national 

health expenditure accounts, maintained by the Centers 

for Medicare and Medicaid Services.

CBO A series of issue summaries from

the Congressional Budget Office

OCTOBER 26, 2009

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

0

2

4

6

8

10

12
2 CONGRESSIONAL BUDGET OFFICE

ECONOMIC AND BUDGET ISSUE BRIEF

Figure 2.

Average Annual Approvals of New Drugs by the Food and Drug Administration, 

1970 to 2008

(Number)

Source: Congressional Budget Office based on data from the Food and Drug Administration.

Notes: The data, which are for new molecular entities (NMEs) only, exclude extensions and new approved uses of existing drugs. New molecular entities are drugs based on a molecule not used before in any pharmaceutical product. Priority drugs are those that, according to 

the Food and Drug Administration, provide a “significant therapeutic or public health advance.”

Beginning in 2004, approvals include those for biologics (large-molecule drugs such as monoclonal antibodies, growth factors, and 

recombinant proteins). The Food and Drug Administration approved five such drugs in 2004 (four given priority status); two in 2005 

(both priority drugs); four in 2006 (all priority drugs); two in 2007 (one priority drug); and three in 2008 (two priority drugs). See 

www.fda.gov/cder/rdmt/default.htm.

The Rate of New-Drug Development

The rising-then-slowing pattern of growth in prescription 

drug spending (shown in Figure 1) is related to the 

evolving pace of new-drug introductions and patent expirations over the past two decades. Many of the new drugs 

introduced in the 1990s enabled physicians to treat previously untreated or undertreated conditions, and growth 

in spending on prescription drugs naturally accelerated. 

Drug introductions spiked in the mid- to late 1990s but 

have declined since 2000—in most years, back to levels 

not seen since the 1980s. The introduction of priority 

drugs—drugs that, according to the Food and Drug 

Administration (FDA), provide a “significant therapeutic 

or public health advance”—has also slowed, from an average of more than 13 a year in the 1990s to about 10 a 

year in the 2000s (see Figure 2).

With the decline in priority-drug approvals, a key source 

of rising drug expenditures—a rise in the number of topselling drugs—has subsided. Between 1996 and 2006, 

the number of drugs with annual sales of $1 billion or 

more (in 2000 dollars) increased from 6 to more than 50, 

and the share of industry revenues produced by those 

“blockbuster” drugs rose from around 12 percent to 

nearly 50 percent. Since then, patent expirations and the 

arrival of competition from generic drugs have apparently 

reduced the revenue from brand-name drugs more 

quickly than it is being replaced by revenue from the 

introduction of new drugs. The number of drugs reaching $1 billion in annual sales, for example, has started to 

decline.1 For the pharmaceutical industry as a whole, 

slower revenue growth could continue until sales of new 

drugs once again outpace revenue losses from expiring 

patents.

1970–1974 1975–1979 1980–1984 1985–1989 1990–1994 1995–1999 2000–2004 2005–2008

0

5

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30

35

40

Priority NMEs

Standard NMEs

1. Data on the number and revenue share of drugs with billiondollar sales are from Murray Aitken, Ernst R. Berndt, and 

David M. Cutler, “Prescription Drug Spending Trends in the 

United States: Looking Beyond the Turning Point,” Health Affairs, 

Web Exclusive (December 16, 2008), pp. W151–W160.
ECONOMIC AND BUDGET ISSUE BRIEF

PHARMACEUTICAL R&D AND THE EVOLVING MARKET FOR PRESCRIPTION DRUGS 3

Table 1.

Changes in Components of Demand for Prescription Drugs, 

Selected Years, 2000 to 2008

Source: Congressional Budget Office based on data from U.S. Census Bureau, www.census.gov/prod/2008pubs/09statab/health.pdf; and 

National Association of Chain Drug Stores (2008 data are from www.nacds.org/pdfs/Pharmacy/2008CommunityPharmacyResults. 

pdf).

a. Includes chain drug stores, independents, mass merchants, supermarkets, and mail-order pharmacies; excludes in-patient prescriptions.

b. Adjusted for inflation using the gross domestic product implicit price deflator.

c. Excludes mail order.

d. Value for 2007.

Slower revenue growth for drugmakers does not mean 

that consumers are using fewer prescription drugs. In 

fact, the number of prescriptions continues to increase, 

albeit more slowly since 2004 (see Table 1). But generic 

drugs, which cost less than their brand-name counterparts, now comprise a greater share of prescriptions, 

having increased from 42 percent in 2000 to 58 percent 

in 2007.

Investment in R&D

According to Pharmaceutical Research and Manufacturers of America (PhRMA), the industry’s trade association, 

member firms spent $50 billion on pharmaceutical R&D 

in 2008, a 2.6 percent real increase over the amount the 

previous year (see Figure 3).2 That increase is unusually 

small; over the past 30 years, PhRMA has seldom 

reported less than a 5 percent real annual increase in 

R&D spending, and the average has been almost 

9 percent. Because global drug R&D spending is not 

estimated consistently over time, it is difficult to know 

exactly how it has changed. However, PhRMA’s estimates 

account for a majority of that spending. 

Pharmaceutical R&D in the private sector is complemented by health-related research funded by the public 

sector—most of it through the National Institutes of 

Health (NIH). Much of that funding is for basic research 

on the mechanisms of disease, which ultimately supports 

the discovery of new drug therapies. Public funding has 

tended to grow more slowly than private drug R&D 

except from 1998 to 2004, when NIH’s research funding 

doubled in real terms (see Figure 3). It subsequently 

declined by 6 percent over the next four years. However, 

including the one-time increase of $10.4 billion in stimulus funding provided by the American Recovery and 

Reinvestment Act of 2009 (ARRA, Public Law 111-5), 

which remains available through September 2010, real 

growth in NIH’s research funding will nearly equal that 

in private R&D over the 1998–2010 period.

Year

2000 2.9 42 56 178 n.a.

2002 3.1 42 65 215 10.4

2004 3.3 48 70 246 7.2

2006 3.4 53 70 263 3.5

2008 3.5 58 d 72 265 d 0.8

Real Expendituresb

Total

Average Annual

(Percent)

Average per

Prescriptionc

(Dollars) (Billions of dollars)

Prescriptions Filleda

(Billions)

Market Share of 

(Percent)

Generic Drugs Increase in Total

2. See Pharmaceutical Research and Manufacturers of America, 

Pharmaceutical Industry Profile 2009 (Washington, D.C.: 

PhRMA, April 2009), Table 1, p. 50; Table 2, p. 51; Figure 9, 

p. 32. About three-quarters of total R&D spending consists of all 

spending by U.S.-owned companies and U.S. spending by 

foreign-owned companies; the remaining one-fourth reflects 

overseas R&D spending by U.S. subsidiaries of foreign-owned 

firms. The total excludes non-U.S. R&D spending by non-U.S. 

companies. (In addition, other pharmaceutical firms based in the 

United States but not belonging to PhRMA spent $15 billion.)
4 CONGRESSIONAL BUDGET OFFICE

ECONOMIC AND BUDGET ISSUE BRIEF

Figure 3.

Annual Spending on R&D by Drug 

Companies and on Research by the 

National Institutes of Health, 

1980 to 2008

(Billions of 2008 dollars)

Source: Congressional Budget Office based on data from 

Pharmaceutical Research and Manufacturers of America, 

Pharmaceutical Industry Profile 2009 (Washington, D.C.: 

PhRMA, April 2009); and National Science Foundation, 

Federal Funds for Research and Development (various 

years), www.nsf.gov/statistics/fedfunds. Data from 

PhRMA members are self-reported.

Notes: Spending amounts are adjusted for inflation using the gross 

domestic product implicit price deflator.

PhRMA = Pharmaceutical Research and Manufacturers of 

America; NIH = National Institutes of Health.

a. About three-quarters of total spending on research and development (R&D) consists of spending by U.S.-owned companies 

and U.S. spending by foreign-owned companies; the remaining 

one-fourth reflects overseas spending on R&D by U.S. subsidiaries of foreign-owned firms. The total excludes non-U.S. R&D 

spending by non-U.S. companies.

Analysts have found that increased public spending 

on basic (health-related) research stimulates additional 

private drug R&D.3 Conversely, slower growth in public 

R&D spending could mean fewer new opportunities for 

drug development. Basic research can also help reduce the 

costs of R&D. For example, advances in biomedical 

science could provide ways to identify potential failure 

earlier in the development process, reducing the amount 

spent on failed drugs. In pharmaceutical research, the 

time and resources spent on drugs that ultimately fail in 

clinical trials account for a substantial fraction of total 

R&D spending.

Companies’ R&D expenditures depend on the number 

of projects, their duration, the probability of failure, and 

financing costs. Scientific advances can reduce R&D 

costs for particular kinds of drugs but can also open up 

new areas of drug development that may be costly to pursue. R&D financing costs can be affected by revenue 

growth. Established drug companies—those with a variety of drug products on the market—can finance R&D 

using revenues from sales of existing drugs. If faced with 

slower revenue growth, however, some firms might turn 

to outside investors, who—because they know less about 

the firm’s research progress and odds of success—would 

generally demand a higher return to compensate for that 

uncertainty, slightly raising R&D costs.

Real R&D spending per successful new drug has been 

rising for many years, largely because of growth in the size 

and length of clinical trials and an increased rate of 

failure. Those changes generally reflect drug companies’ 

strategic choices about which kinds of drugs to pursue—

choices that depend on anticipated demand and scientific 

opportunities. In particular, drug companies are devoting 

more resources to developing drugs for chronic illnesses.4

In many cases, those drugs require prolonged use, so longer clinical trials are necessary. 

Development times vary by type of drug but have 

been averaging about 12 years from discovery through 

clinical trials to approval by the FDA. Although private 

drug companies have been pursuing increasingly costly 

R&D projects, they would not do so if they did not 

expect to recoup their investment through sales of the 

resulting drug products.

3. Michael R. Ward and David Dranove, “The Vertical Chain of 

Research and Development in the Pharmaceutical Industry,” 

Economic Inquiry, vol. 33, no. 1 (January 1995), pp. 70–87.

1980 1984 1988 1992 1996 2000 2004 2008

0

10

20

30

40

50

60

PhRMA R&Da

NIH Research

4. Joseph A. DiMasi, Ronald W. Hansen, and Henry G. Grabowski, 

“The Price of Innovation: New Estimates of Drug Development 

Costs,” Journal of Health Economics, vol. 22, no. 2 (March 2003), 

p. 181.
ECONOMIC AND BUDGET ISSUE BRIEF

PHARMACEUTICAL R&D AND THE EVOLVING MARKET FOR PRESCRIPTION DRUGS 5

The Role of Health Insurance in the 

Demand for Prescription Drugs and 

Drug R&D

The scope of health insurance coverage of prescription 

drugs has been expanding for many years. From 1997 to 

2007, the share of consumers’ total drug expenses paid 

for by third parties (private health insurance plans and 

public programs) rose from 67 percent to 79 percent.5 At 

least partly as a consequence, the number of prescriptions 

filled has risen substantially, increasing by 72 percent over 

the same period.6

Insurance plays a significant role in determining the 

demand for prescription drugs and, ultimately, drug 

R&D. By shielding individuals from the full costs of the 

drugs they use, insurance encourages higher spending on 

drugs. For example, spending can increase when insured 

individuals fill prescriptions that they would have forgone 

if they lacked insurance or when those individuals choose 

a more expensive drug than they would have if they faced 

the full cost. 

Insurance plans have sought to control the growth in 

their drug expenditures by adjusting the cost-sharing 

provisions in their policies to encourage beneficiaries to 

make cost-effective choices. A typical policy now provides 

generic drugs to beneficiaries in exchange for a relatively 

small copayment but requires somewhat higher 

copayments for “preferred” brand-name drugs and still 

higher copayments for “nonpreferred” brand-name drugs. 

Some brand-name drugs may be placed in the preferred 

tier because of their unique therapeutic benefits; others 

are put in that tier because the manufacturer has offered 

the insurance plan a price concession. Copayments for 

brand-name drugs in the preferred and nonpreferred tiers 

have been rising more quickly than have those for generic 

drugs (see Figure 4), strengthening incentives to choose 

generics.

The creation of the Medicare Part D drug benefit in 2006 

is a prominent example of how an expansion in coverage 

affects the demand for prescription drugs and alters 

incentives to undertake drug R&D. With Part D in 

place, the fraction of U.S. seniors who have drug coverage 

increased from about three-quarters before the program 

began to around 90 percent in early 2009, a gain of 

around 8 million covered individuals.7

 That coverage 

expansion almost certainly contributed to the growth in 

the number of prescriptions in recent years, although 

health plans participating in Part D often give their 

enrollees incentives to make cost-effective drug choices. 

Some tentative evidence suggests that, as a result of 

demographic shifts and increased demand from Medicare 

beneficiaries, drugmakers are devoting more R&D 

resources to developing drugs for conditions related to 

aging.8 That finding is consistent with the more general 

results from a number of studies showing that spending 

on drug R&D is responsive to changes in demand: On 

average, R&D spending has been found to go up by an 

average of about 1 percent for every increase of 1 percent 

in potential sales.9

 The fraction of the population that is 

older than 65 is projected to rise from about 13 percent 

to about 20 percent during the next 20 years.10 That 

demographic change, combined with the greater demand 

for drugs resulting from Part D, will continue to influence private R&D investment for some time. 

Policy Options and Their 

Implications for R&D

The federal government finances a large and growing 

share of prescription drug sales—roughly 29 percent in 

2007 compared with less than 15 percent five years 

5. Congressional Budget Office calculation based on data on spending on prescription drugs, as defined in the national health expenditure accounts, maintained by the Centers for Medicare and 

Medicaid Services.

6. Kaiser Family Foundation, Prescription Drug Trends (September 

2008), p. 2.

7. For pre-Part D coverage, see Congressional Budget Office, Issues 

in Designing a Prescription Drug Benefit for Medicare (October 

2002), and Dana Gelb Safran and others, “Prescription Drug 

Coverage and Seniors: Findings from a 2003 National Survey,” 

Health Affairs, Web Exclusive (April 19, 2005), pp. W5–W160. 

For coverage under Part D, see Kaiser Family Foundation, The 

Medicare Prescription Drug Benefit (March 2009).

8. See Margaret E. Blume-Kohout and Neerag Sood, The Impact of 

Medicare Part D on Pharmaceutical Research and Development, 

Working Paper 13857 (Cambridge, Mass.: National Bureau of 

Economic Research, 2009).

9. See, for example, F.M. Scherer, “Price Controls and Global 

Pharmaceutical Progress,” Health Affairs, vol. 28, no. 1 (2009), 

pp. W161–W164. 

10. Wan He and others, 65+ in the United States: 2005, Current 

Population Reports, Series P23-209 (U.S. Census Bureau, 

December 2005), Figure 2-6, p. 12, www.census.gov/prod/

2006pubs/p23-209.pdf.
6 CONGRESSIONAL BUDGET OFFICE

ECONOMIC AND BUDGET ISSUE BRIEF

Figure 4.

Average Copayment for a Prescription Drug, by Tier, 

Selected Years, 2000 to 2008

(Dollars)

Source: Congressional Budget Office based on data from Kaiser Family Foundation and Health Research and Educational Trust, Employer 

Health Benefits: 2009 Annual Survey (Washington, D.C.: Kaiser/HRET, 2009), Exhibit 9.4.

Note: Tier 1 (generic) drugs are copies of brand-name drugs whose patents have expired and that therefore may be produced and 

distributed by multiple drug companies. Tier 2 (preferred) drugs are brand-name drugs that typically are still protected by patents 

and therefore have no generic substitute. Tier 3 (nonpreferred) drugs are brand-name drugs that typically have a generic substitute.

earlier—and it faces severe long-term budgetary pressures, with rising health care costs playing a key role. 

A number of policy options for reducing those costs or 

for expanding insurance coverage would affect the market 

for prescription drugs. This section presents a sampling 

of such options—some of them detailed in the Congressional Budget Office’s December 2008 report Budget 

Options, Volume 1: Health Care. All of them have potential implications for the revenues that drug companies 

would expect to earn from new products and, therefore, 

for the incentives to invest in drug R&D. In general, 

policies that would lower expectations about revenues 

would discourage R&D investment, and those that 

would raise expectations would stimulate R&D. For 

some policies, the effects on expected revenues would 

vary by product or therapeutic area; total R&D investment might not be affected, but patterns of R&D 

resource allocations could be.

Expand Prescription Drug Coverage

The Congress is considering proposals that would 

increase the fraction of the population covered by health 

insurance. Depending on the breadth of the expansion 

and the provisions for drug coverage, such proposals 

would probably increase the quantity of prescription 

drugs purchased in the United States. A simple expansion 

in health insurance coverage—for example, broader eligibility criteria for Medicaid—would increase drugmakers’ 

current and expected future revenues, making investing 

in R&D more attractive for drug companies. However, 

the impact of a major health care reform proposal on 

incentives to undertake R&D would depend not just on 

the number of newly covered individuals but also on 

other factors such as changes in payment policy.

Expand the Medicaid Rebate Paid by Manufacturers 

of Brand-Name Drugs

In the fee-for-service part of Medicaid, drugmakers pay a 

rebate to Medicaid for each drug that the program purchases on behalf of its beneficiaries. For brand-name 

drugs, that rebate has two components. The first part, 

known as the basic rebate, equals 15.1 percent of a drug’s 

average manufacturer price (AMP—the price that the 

drugmaker receives from sales to retail and mail-order 

pharmacies) or, if it is greater, the difference between the 

AMP and the lowest transaction price (the “best price” 

that the drugmaker receives from sales to certain private 

buyers). The second part, the additional rebate, equals 

Tier 1: Generic Tier 2: Preferred Tier 3: Nonpreferred

0

5

10

15

20

25

30

35

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45

50

2000 2004 2008
ECONOMIC AND BUDGET ISSUE BRIEF

PHARMACEUTICAL R&D AND THE EVOLVING MARKET FOR PRESCRIPTION DRUGS 7

the difference between a drug’s current AMP and the 

AMP at the time it was originally marketed, adjusted for 

inflation using the consumer price index for urban 

consumers (CPI-U). (Drugmakers owe no additional 

rebate if growth in a drug’s AMP does not exceed growth 

in the CPI-U.) 

The President’s 2010 budget proposes changes to both 

components of the rebate for brand-name drugs. For the 

basic rebate, the President’s budget would raise the flat 

rebate percentage from 15.1 percent to 22.1 percent, 

yielding savings for the federal government and state governments.11 A potential drawback is that drugmakers, 

faced with reduced revenues from Medicaid, might invest 

somewhat less to develop drugs whose sales would be 

concentrated in the Medicaid program. 

The President’s 2010 budget also includes a proposal to 

alter the additional rebate by treating many future modifications of existing drugs more like the original product 

in calculating rebate obligations. Under current law, a 

drugmaker can avoid the additional rebate by slightly 

modifying an existing product; doing so establishes a new 

AMP that can exceed the inflation-adjusted AMP of the 

old product without triggering an additional rebate. The 

proposed change would lead to savings for the federal and 

state governments because rebates would increase. That 

policy would make it somewhat less attractive for drugmakers to improve existing drugs, although if the clinical 

benefits of those improvements were sufficiently great, 

manufacturers would still find it worthwhile to develop 

them because of the higher prices they could command 

outside the Medicaid market.

Require Drugmakers to Pay a Minimum Rebate on 

Drugs Covered by Medicare Part D

Some proposals would require manufacturers of 

brand-name drugs to pay the federal government a rebate 

equal to 15 percent of the price they receive from sales of 

drugs for Part D beneficiaries to retail and mail-order 

pharmacies, plus an additional rebate if a drug’s price 

grows faster than inflation. Such a policy would reduce, 

by the amount of those rebates, the manufacturers’ 

expected revenues from sales for Medicare beneficiaries. 

That, in turn, would reduce manufacturers’ incentives to 

invest in R&D on products that would be expected to 

have significant Medicare sales.

Increase the Availability and Use of Follow-On 

Biologic Drug Products

Biologics—drug products derived from living organisms—constitute a small but growing share of health care 

spending. Some biologics face competition from other 

brand-name drugs that have similar therapeutic effects. 

For example, several competing brand-name biologics are 

used to treat rheumatoid arthritis. To date, however, 

brand-name biologics face no competition from followon imitators in the way that conventional brand-name 

drugs do (from generic compounds) when their patents 

expire. The absence of such competition makes it more 

difficult for private health plans to negotiate discounts for 

biologics.

The Congress is considering proposals that would 

establish an abbreviated regulatory pathway for approving 

follow-on biologics under the Public Health Service Act. 

(Such proposals aim to create a streamlined process analogous to the one for generic drugs under the Federal Food, 

Drug, and Cosmetic Act.) Also, the Medicare Payment 

Advisory Commission (MedPAC) has recommended 

changes to Medicare’s payment incentives that would 

encourage the use of follow-on biologics as they become 

available. 

The overall impact of such policy changes on R&D is 

difficult to predict. An abbreviated regulatory pathway 

and stronger incentives for doctors or patients to choose 

follow-on biologics would encourage investment in the 

development of those imitative products and reduce the 

expected returns to R&D from original, pioneering 

biologics. However, there would probably be fewer 

manufacturers of imitative biologics than there are of 

conventional generics because biologics are far more complex and more costly to develop than are conventional 

drugs. So the reduction in the returns to R&D from 

pioneering biologics—and therefore in the incentives to 

undertake that R&D—might not be great.

11. CBO previously analyzed a similar policy option, specifically, raising the basic rebate percentage from 15.1 percent to 23.1 percent 

while maintaining the best-price provision. That option would 

reduce the federal deficit by $7.2 billion over the 2010–2019 

period. See Option 74 in Congressional Budget Office, 

Budget Options, Volume 1: Health Care (December 2008). For 

background on rebates, see Congressional Budget Office, “The 

Rebate Medicaid Receives on Brand-Name Prescription Drugs,” 

letter to the Honorable Charles E. Grassley (June 21, 2005).
8 CONGRESSIONAL BUDGET OFFICE

ECONOMIC AND BUDGET ISSUE BRIEF

Incorporate Findings on Comparative Effectiveness 

into Decisions About Insurance Coverage

The Congress recently expanded government support for 

research on the comparative effectiveness of various medical treatments for patients with particular conditions.12

Many medical experts suggest that creating more data on 

comparative effectiveness and providing appropriate 

financial incentives to encourage the use of those data 

could allow payers to slow the growth in health care costs 

and also improve the quality of care. If payers could do 

that, drug companies might invest less in the development of so-called me-too drugs—new products with 

effects similar to those of an existing class of drug—

because they would anticipate earning less revenue from 

such products if a comparative effectiveness (CE) study 

showed that they were no better than existing drugs. 

Drug manufacturers’ incentives to develop highly innovative, breakthrough products would not necessarily 

decline, however.

The effects of CE data on pharmaceutical revenues are 

difficult to predict because it is not possible to know 

beforehand what a CE study would find. (Nor is it 

possible to know exactly which therapies would be 

studied.) So it is not clear what effects increased support 

for CE studies would have on pharmaceutical R&D. 

Some CE studies might find that a newer, costlier brandname drug confers few or no added benefits compared 

with those from cheaper compounds. If payers responded 

by discouraging the use of that drug, or if they limited its 

use to a restricted set of patients for whom substantial 

clinical benefits could be demonstrated, the revenues 

from that drug would be lower. Other CE studies might 

find that a particular drug confers benefits comparable 

with or superior to those from a costly medical procedure. Such a finding would lead to more widespread use 

of that drug and to higher revenues for its manufacturer.

Health plans could use findings from CE studies to 

negotiate more effectively with drug manufacturers over a 

drug’s price and its placement within the plans’ drug formularies. However, such studies can be costly: Because 

differences between drugs are likely to be narrower than 

those between a drug and a placebo, CE studies can—for 

statistical reasons—require larger, more costly clinical 

trials. Establishing criteria for deciding which treatments 

to compare could help ensure that resources are expended 

cost-effectively on CE studies, and public-sector sponsorship of those studies could contribute to greater objectivity in their findings.

12. For a discussion of research on comparative effectiveness and its 

possible effects on future health care spending, see Congressional 

Budget Office, Research on the Comparative Effectiveness of Medical 

Treatments: Issues and Options for an Expanded Federal Role

(December 2007). 

David Austin and Colin Baker prepared this brief. 

It and other CBO publications are available at the 

agency’s Web site (www.cbo.gov).

Douglas W. Elmendorf

Director