US innovation goes global

Markets for innovative goods involve significant spillovers in a global economy. When US consumers pay higher prices for drugs, this stimulates innovation that benefits consumers all over the world. Conversely, when large European markets restrict prices and profits, foreign consumers bear some of the long-run cost in the form of less innovation. The result is a free-riding problem at a global level. These incentives are particularly strong for smaller markets, whose policies have relatively little impact on global innovation, but can have relatively large impacts on national pharmaceutical budgets. The result is a system in which the largest countries bear disproportionate burdens for stimulating innovation. Using a microsimulation approach, we estimate the impact of these incentive effects. The model’s baseline estimates demonstrates that the US adoption of European-style price controls would harm consumers in the US and Europe; over a 50-year period, it would cost $8 trillion in the US, and $5 trillion in Europe. Similarly, repealing European price controls would add $10 trillion to the wealth of US society, and $6 trillion to wealth in Europe. Even under the most conservative assumptions, adopting price controls generates at best a small benefit, but risks a large cost. On the other hand, reducing pharmaceutical copayments would increase wealth in both societies, a result which is robust to a wide variety of parameter values. Go to: A. Introduction The United States is by far the largest market for pharmaceuticals. In 2005, the United States accounted for 42% of global sales, while Europe accounted for 29%.1 This difference is due in large part to more aggressive price negotiation by public insurance programs in Europe. While exact comparisons are difficult, the data suggest that European consumers pay 50% to 70% less for a given quantity of drugs.2 The higher profits in America contribute to the view of the United States as the engine for global pharmaceutical innovation. While some critics have questioned the link between profits and research and development (R&D), the absence of R&D into unprofitable third-world diseases and the increase in R&D for certain rare diseases after passage of the US Orphan Drug Act demonstrate otherwise. Evidence suggests that lower profits delay the launch of new drugs, limit the availability of new drugs, and ultimately reduce the pace of innovation (cf, Acemoglu and Linn, 2004; Finkelstein, 2004; Danzon, Wang, and Wang, 2005). New treatments are of value to the entire globe, not just to the society that discovered them. Thus, spending by Americans encourages innovations that benefit both Europe and America, and the reverse is also true. There are certainly profits to be made in Europe, and these will affect the global pace of innovation as well. In this way, pharmaceutical pricing policies in Europe and the United States are inextricably linked.