This week I conducted my first-ever line of questioning at an Oversight committee hearing, which focused on the skyrocketing costs of pharmaceuticals.— Alexandria Ocasio-Cortez (@AOC) February 1, 2019
Here’s what happened ⬇️ https://t.co/M6XuL61zXN
In these short videos (which email subscribers to this blog need to click through to see), Ocasio-Cortez and Ro Khanna are seen asking questions during a Jan. 29 House Oversight and Reform Committee hearing, "Examining the Actions of Drug Companies in Raising Prescription Drug Prices." So far, @AOC's three tweets about this issue have generated over 7,000 comments, 58,000 retweets, and 190,000 likes.Big Pharma companies often say that drugs “need” to be expensive to fund research. What they don’t tell you is that they use *publicly-funded research* for expensive, privatized drugs.— Alexandria Ocasio-Cortez (@AOC) February 1, 2019
This week on Oversight, @RoKhanna and I exposed how this scheme works:pic.twitter.com/ELbllU3Fxy
Privatization of publicly funded research through patents is one of my main areas of research, so I love to see it in the spotlight. There are enough concerns with the current system that the government should be paying attention. But as I explain below, condensing Ocasio-Cortez and Khanna's questions into a headline like "The Public, Not Pharma, Funds Drug Research" is misleading. Highlighting the role of public R&D funding is important, but I hope this attention will spur more people to learn about how that public funding interacts with private funding, and why improving the drug development ecosystem involves a lot of difficult and uncertain policy questions. This post attempts to explain some key points that I hope will be part of this conversation.
1. Pharmaceutical development currently depends on both public and private funding, with public funding playing the largest role in basic sciences discoveries that indirectly lead to new drugs.
According to the National Science Foundation, out of the $495 billion spent on U.S. R&D in 2015, the federal government funded $121 billion—about one-quarter. Figuring out the portion of this R&D that might be relevant to the pharmaceutical industry is difficult, but most of it would be funded by the National Institutes of Health (NIH), which has an annual budget around $39 billion. The U.S. pharmaceutical industry performed over $58 billion in R&D in 2015, with 99.8% of this funding coming from private industry.
How significant are these different funding sources for new drug approvals? It depends on how you count. As Suzanne Scotchmer has explained, new discoveries build on old ones, and the pharmaceutical industry is no exception. If you consider all of the basic science and research tools that make new medical discoveries possible, every innovation can surely be traced to public R&D. (For an accessible read on this topic, see here.) If you are interested in the more direct costs of developing a specific new drug, however, most of the price is still being paid by the private sector.
To illustrate the distinction between direct and indirect influence: Bhaven Sampat and Frank Lichtenberg found that of drugs approved by the FDA from 1998 to 2005, 9% of all drugs and 17% of "priority-review" drugs (those reflecting "significant improvements") have at least one public-sector patent (i.e., a patent based on publicly funded R&D), though they will typically have private-sector patents as well. But a much higher portion reflected more indirect influence of public R&D: half of all drugs and two-thirds of priority-review drugs had a private-sector patent that cited a public-sector patent or publication. An even more expansive measure of indirect influence was used in the 2018 PNAS study by researchers at Bentley University that Khanna is referring to when he asks about "the study that shows that between 2010 and 2016, of every drug, all 210 drugs that were approved by the FDA, were funded by the NIH or public money." As the study notes, ">90% of this funding represents basic research related to the biological targets for drug action." This basic science is crucial, and expensive. But it does not mean that the private sector does not fund drug R&D: later-stage research also carries an enormous pricetag.
Assessing the impact of public R&D is difficult, but some cutting-edge economic research is making progress on these questions. I recently reviewed one such study, which concludes that each $10 million in NIH funding in fact generates 2.7 additional private-sector patents, as opposed to being merely correlated with private-sector advances or crowding out private investment. This study helps justify the large federal expenditures on biomedical R&D, but it does not address the relative importance of public and private sector R&D investments.
2. Late-stage pharmaceutical development requires expensive clinical trials that are primarily financed by private firms, which depend on having sufficient patent protection to recoup development costs.
Ocasio-Cortez and Khanna's comments sound similar to the "paying twice" critique of patents on publicly funded inventions: Why should U.S. taxpayers have to pay supracompetitive prices on patented products when they have already paid for the initial research? This critique seems most compelling for products that are actually covered by public-sector patents—e.g., a patent on a federally funded university invention that is exclusively licensed to a private firm.
But the problem is that many inventions are very far from commercialized products. A university might patent a promising drug candidate based on studies in petri dishes or animals, but the FDA won't approve the drug until it has been through expensive clinical trials that demonstrate safety and efficacy in humans. Currently, most clinical trials are conducted by for-profit firms, and as Ben Roin has explained, pharmaceutical companies screen any drugs with insufficient patent protection out of their development pipelines. Daniel Hemel and I have questioned why there is not more government investment in clinical trials (see p. 570 here), but given the current institutional structures for drug development, if publicly funded drug candidates couldn't be patented and exclusively licensed to private companies, many of them would never make it to market.
This commercialization argument is the primary justification for allowing federally funded inventions to be patented and exclusively licensed, as is permitted under the Bayh–Dole Act of 1980. To be clear, however, this theory cannot justify the Act's present scope. As I have explained in work with Ian Ayres, many federally funded inventions do not require exclusivity to be brought to market. Universities and other recipients of federal research funding should either limit exclusivity to just what is needed for commercialization or do more to justify greater patent rights—and perhaps pressure from Congress can help with this.
3. Some pharmaceuticals generate profits that far exceed their risk-adjusted cost of development, but this doesn't mean that pharmaceutical profits are uniformly too high—in some cases, expected profits seem too low.
Many pharmaceutical prices seem difficult to justify from a public welfare perspective. A recent study of 99 cancer drugs approved by the FDA from 1989 to 2017 found a return of $14.50 per $1 of risk-adjusted R&D spending. Researchers at Yale estimated that Gilead's hepatitis C drugs brought in forty times their development cost in just the first 27 months. Specific instances of pharmaceutical profiteering have led to headlines and public outcry.
But what we don't see are the drugs that are never developed because firms don't expect a sufficient return. These nonexistent drugs can't be counted, but a clever empirical study by Eric Budish, Ben Roin, and Heidi Williams demonstrated R&D investment distortion away from cancer drugs with shorter effective patent protection. Other empirical work has demonstrated the link between expected profits and R&D in other ways: Medicare Part D significantly increased pharmaceutical R&D for drugs targeting older patients; policies focused on increasing returns for developing vaccines and orphan drugs were effective; and introduction of a new drug in a given country seems to be delayed by price controls but accelerated by strong patent rights.
In short, incentives matter. There are lots of ways in which market incentives aren't well aligned with social welfare, and many good arguments that drug development incentives should be less dependent on patent rights. Think, for example, of unpatentable interventions, or products with negative externalities, or innovations for populations with low ability to pay. But policymakers considering pharmaceutical price regulation should recognize that current incentives are not uniformly too high. As summarized by Darius Lakdawalla, "whether innovation is too high or too low is a first-order—perhaps the first-order—policy question in the economics of the pharmaceutical industry."
4. Requiring private firms that make use of public research to provide the public with a return on investment is more complicated than it sounds.
Ocasio-Cortez seems particularly concerned that "the public is acting as an early investor, putting tons of money in the development of drugs that then become privatized, and then they receive no return on the investment that they have made." But it's not obvious that this kind of return on investment makes sense.
First, it would be logistically and legally difficult to require some kind of return based on all the indirect influence discussed above, such as basic science findings that don't result in a patent. For publicly funded research that does result in a patent, the patenting institution (e.g., a university) does receive a return in the form of equity or royalties. But (1) this is a relatively small return, with many university technology transfer offices operating in the red (see p. 291-94 here), and (2) Congress has directed patenting institutions to reinvest any net income in science research and education, so in this sense, the public is receiving a return—it is just not going back through the federal budget.
Congress could require a more significant return on investment, such as requiring firms that profit from publicly supported research to repay those grants—and perhaps more—out of their profits. I have discussed some arguments in favor of such a system, but I have also explained (in work with Daniel Hemel) that "if government-set rewards are targeted toward knowledge goods that the market underestimates, then reducing the market-generated reward for these knowledge goods may be counterproductive" (p. 579 here).
5. There are a lot of open empirical questions about privatization of publicly funded research and its connection to pharmaceutical prices.
There are open questions about pharmaceutical economics, and about patents in general, and about how best to spend public R&D money (though thinking longer term is probably a good step!). And there are lots of questions about how these areas intersect under the Bayh–Dole Act, and whether that system could be improved.
I am convening a small group of leading economists and legal scholars next month to try to reach consensus on what is currently known, what the important open questions are, and what policy recommendations we might have. But given the empirical uncertainty, it is particularly important that any policy changes be implemented in a way that aids robust evaluation. And I welcome dialog with scholars or policymakers interested in tackling these problems.