What policymakers should know about the link between drug revenues and new treatments

Prescription drug prices, always a sore point for consumers, have become a front-burner political issue for policymakers in both parties heading into this campaign cycle. The Trump administration claims that reducing the price of drugs is one of its highest priorities and recently issued new regulations requiring manufacturers to list the price of their drugs in television ads. Congress meanwhile passed two price transparency bills last year and is holding a set of hearings on the subject, which could lead to bipartisan legislation that would reduce government spending on drugs by up to $100 billion over the next decade. And now Speaker Nancy Pelosi has introduced legislation forcing drug makers whose products do not face competition to dramatically lower their prices in order to sell in the United States.

The affordability of drugs clearly deserves a thoughtful policy response. But as Congress and the administration consider possible remedies, policymakers need to keep in mind the unique dynamics of the drug industry. As a recent report by the Information Technology and Innovation Foundation documents, there is a strong relationship between the revenues drug companies earn on their current products and the amount of research they conduct on the next generation of treatments that future patients will need.

As ITIF’s report shows, numerous academic studies have examined the relationship between prices, profits, and market size for drugs on the one hand and research, innovation, and new drugs on the other. All of them show a strong positive relationship. This should not be surprising. In 2014, pharmaceutical firms in the United States led other industries and the rest of the world in pouring 43.8 percent of their value added back into research. It is important that they profit from the social value this research creates, because more often than not the research leads to dead ends, and even the most promising treatments take a long time to make it from the research stage to final drug approval. A Congressional Budget Office study estimated that, in order to earn an average return of 4.8 percent, drug companies need to earn a 62.2 percent margin on the projects that turn out to be successful.

Congress also needs to keep in mind that we need more private research, not less — and being able to tap into profits is a cheaper way to finance new research than using either equity or debt. Yet, even at current drug prices, companies only receive a small fraction of the social value they create. One study estimated the benefits from new HIV/AIDS drugs at nearly $1.4 trillion, but company profits only increased by $62.9 billion. The remaining 96 percent of benefits went to patients and other participants in the health care system. More broadly, in three-fourths of the cases the researchers reviewed, the public received at least 75 percent of the total benefits created by a new drug.

The value of new drugs can be quite large. A 2015 report by the Alzheimer’s Association estimated that if a drug set to arrive in 2025 delays the onset of the disease by only five years, it would still save society almost $1 trillion in just the first 10 years. Even expensive drugs can deliver great savings. Zolgensma, which costs $2.1 million for a one-time therapy, treats spinal muscular atrophy, a rare disease that, if left untreated, severely handicaps or kills infants. The only previous therapy costs $750,000 for an initial treatment, but $375,000 per year afterwards — which quickly exceeds the higher initial cost of the new therapy.

While the desire to lower costs is understandable, some reforms to help today’s patients would harm patients in the future by reducing the incentive to invest in new research. In 1986, biopharmaceutical research in the European Union exceeded research in the United States by 24 percent. However, the widespread implementation of price controls during the early 1990s shifted the center of the industry firmly to the United States. By 2004, U.S. research exceeded that being conducted in the EU by 15 percent. According to one study, a 10-percent rise in inflation-adjusted drug prices caused firms to increase their R&D intensity by nearly 6 percent the following year.

A number of reforms could lower the impact of drug pricing without disrupting the incentives for future research. First, the United States should press other developed nations to pay their fair share of the cost of developing new drugs. Artificially low prices in European markets put upward pressure on U.S. prices. A report by the Council of Economic Advisors estimates that Americans pay 70 percent of global biopharmacutical profits even though they account for only half of the world market. Congress should also reform health care markets so that more Americans have affordable health insurance, including for the drugs they need. Third, a recent paper estimates the industry could save over $50 billion per year if drug manufacturing was more efficient. Finally, Congress should speed drug discovery by both loosening restrictions on the use of patient data in drug discovery and increasing federal spending on basic research.

Americans deserve affordable prescription drugs. But they also deserve the world’s most competitive and innovative biopharmaceutical industry and the steady supply of innovative cures it produces. They can have both, but only if drug prices continue to reflect the social value that they create.

Joe Kennedy is a senior fellow at the Information Technology and Innovation Foundation, the world’s leading think tank for science and technology policy.