Tuesday, October 17, 2006

2005 Medicines Forever

I have just come across a fascinating study that confirms a central prediction made in one of my favorite articles on state versus private health-care systems. That article is by Ronald Bailey, is called “2005 Medical Care Forever”(hence the tribute title of this piece) and appears in Reason magazine. In it the author contends that the primary fault of single-payer healthcare is that it divorces contending consumer health-care desires from the signals given to health-care producers. As with everything else, consumers of market-based health care are given a channel to reveal their willingness to pay that most effectively induces producers to produce the greatest quantity of health care at the lowest available cost. Other things equal, a higher willingness to pay translates into higher prices for producers, as does lower cost of provision, giving them the incentive to devote more resources to that activity. In a market-based system, for example, nurses might be substituted for doctors if they're able to deliver care as effectively for considerably lower cost, and drugs might be substituted for surgical procedures for the same reason. Provided manufacturers get to keep some of the surplus, they have an incentive to develop drugs that do just that.

When government officials make the call on what kinds of health care get provided and what kinds do not, some mechanism other than the bidding of money must be found. Resources might go to those with the most political influence – those able to vote in the largest numbers, those able to generate political pressure through means other than voting most effectively, etc. (It should be noted that the US has a system in which the state is already heavily entangled in these decisions, so we are no saints. The recent Medicare prescription-drug benefit is Exhibit A in this regard.)

What Mr. Bailey contends is that the absence of market incentives will dull, perhaps completely, the incentive to try to come up with ways to lower health-care costs and increase the value of the health-care services provided. The new study finds evidence in favor of a similar proposition – that pharmaceutical manufacturers respond to the incentives they are given, and when their property rights (including patent protection) are eroded, they devote fewer resources to the creation of value in those areas. In particular, it finds that the United States almost entirely drives pharmaceutical production. If a condition has a big impact on Americans, pharmaceutical companies get busy trying to address it, measured by the number of drug they have in the research pipeline at various stages of development. If it affects Europeans or residents of developing countries, there is no money in treating it, and so pharmaceutical companies ignore it.

In the developing-country case this is in part because these countries are so poor, and there is a clear moral quandary here. Should a disease like schistosomiasis receive relatively little attention because it affects mostly people who can't pay much for new treatments? Clearly not, by most moral criteria, as long as the tradeoffs required to devote more attention to it are acceptable, as they might be if drug treatments for this disease are already available or the research is straightforward. And yet, even in these circumstances it is surprising how little per capita income is required to motivate drug companies. GlaxoSmithKline has just announced second-stage trials in Ghana of a partially effective malaria vaccine, for example. (Malaria is almost entirely a disease of the world’s poorest countries.) The operative question is whether or not bringing drug development under the public sector will work better. Economic theory suggests that basic research may be more likely to be a purely public good, which is the economic justification for the National Institutes of Health and the National Academy of Sciences. And given the impoverishment of those whom they afflict, one could plausibly justify public investment in research designed to develop drugs for diseases that kill significant but not gigantic numbers of people in very poor countries. (Although even in that case, there is an argument to be made for private charity funding such research – think of the Bill and Melinda Gates foundation, which is devoting vastly more to vaccine research than any government on the planet, perhaps than all governments combined.)

The most striking findings are that property rights matter. In this particular study, diseases that occur mostly in poor countries, adjusted for the level of property-rights protection in those countries, actually have a negative effect on drug development. The authors interpret this as suggesting that when property rights are weak, so that governments will allow either the importation of patented medicine or duplication of it by local manufacturers, the citizens of those governments find that their ailments actually deter pharmaceutical manufacturers from addressing them.

The authors finally suggest that policies that allow reimportation of drugs purchased by governments in other countries deter drug development. Why develop an expensive medicine to be sold at high prices to American consumers, when immediately after introduction those consumers will be able to buy it at much cheaper prices from Canadian pharmacies? I don't think I buy this from a long-term perspective. If Canadian importation is allowed, ultimately Canadians will pay prices for their medicines that are much closer to their full social value, which is as it should be. They get away with paying much less now not simply because the government uses its size to negotiate a better rate (which some suggest the American government should do for Medicare), but because once the drug goes on sale in the US, the drug manufacturer is at a disadvantage with respect to Canada or other developed single-payer countries. Once the drug has made its way through the byzantine and extraordinarily costly regulatory process (only one out of 20 drugs that make it into the human-trial process ends up being sold to consumers), its marginal manufacturing cost is very small. And so if it says yes to Canada, and Canadian drugs cannot be reimported into the US, it makes a modest profit on each pill sold in Canada, though far less than in the U.S., which is where it covers the development costs for drugs that succeed and drugs that fail. But if such drugs can be reimported the US, its US prices collapse, and so the drug is never developed to begin with. However, I think in the medium run drug companies faced with the prospect of an open drug border would simply refuse to sell in Canada. In the long run then, the Canadian government would agree to pay more.

But this is just speculation. What is clear is that weak intellectual-property protection in other societies makes pharmaceutical companies less willing to address their most problematic health conditions. And the research equally strongly suggests that when Americans are or get sick, pharmaceutical companies address these conditions very aggressively. Thus, if the US pharmaceutical market were brought under state control (by having the state make decisions about which medicines get made, what price it will pay for them, etc.), the divorce of consumers and producers would be complete, and drug innovation would be brought to a crashing halt. If one wishes to reduce it to numbers, as economists are wont to do, it has been estimated that between 1970 and 1990 pharmaceutical innovation created value for the US economy to the tune of $2.8 trillion per year, or over $12,000 per person. Imagine the emotional disappearance of all medicines you or a loved one have used that has been created in the last, say, thirty years, and you have a more compelling picture of what might await us.

The study, if you’re interested, is Abdulkadir Civan and Michael T. Maloney, “The Determinants of Pharmaceutical Research and Development Investments,” Contributions to Economic Analysis and Policy, 5 (1), 2006.


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