FDA Needs Reform Or The Market Might Not Innovate Life-Saving Drugs.

Okay, maybe those doctoral economists will come in handy. Jokes aside, bringing life-saving drugs to market will never be cheap – and it will require government participation.

However, there’s a difference between red tape syphoning better-spent dollars to line the pockets of insurance companies who DON’T actually care for our population, and making sure a drug company developing an Alzheimer’s treatment can recoup their billion dollar investment.

Seriously, the capitalized cost of bringing a typical drug to market is around $1.2 billion and it’s growing every year. And, thanks in no small part to FDA regulations, this cost is slated to keep growing, especially for new, highly targeted medicines for diseases ranging from cancer to type 2 diabetes.

Much of the cost of drug development lies in what economists refer to as “fixed” or “sunk” costs – this covers the gamut of everything from machinery to rent to regulatory costs (filing fees and time spent conducting clinical trials for example).

This creates a classic underinvestment problem: companies invest significant amounts of money to develop a product (with large social benefits) where they will be unable to capture much of the total benefit (social+private).

The way that we overcome the problem of large sunk costs is by granting companies a temporary monopoly on production and sale of a product. This patent creates “intellectual property” and allows society to encourage investment in high-value, high fixed cost products that may not have been developed otherwise.

Patents are granted for a 20 year period in all countries that have signed the World Trade Organization’s Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs).

The problem is that not all industries are created equal. When Apple unleashes the newest “iWidget,” the engineers who designed it don’t need to prove to the FCC or any other government body that the device is “safe and effective.”

But pharmaceuticals aren’t smartphones. And ensuring the purity, safety, and efficacy of drugs put out on the market serves a tremendous public interest. Nevertheless, FDA clinical trial requirements that help prove safety and efficacy in large populations also create a long lag between invention — i.e. when patents have to be filed — and commercialization — i.e. when the product can be sold.

This isn’t the case with other industries – Apple profits from iPhone sales as soon as the CEO and focus-groups give it a thumbs up.

This “commercialization lag” led to an effective patent life of ~12 years beginning in the 90s. It’s likely to have fallen since then.

And as this effective patent life shortens, it can wreak havoc on U.S. pharmaceuticals. Potentially promising ventures (e.g. “blue-sky” research), with enormous social value (estimates of the value of a cure for cancer have been as high as $50 trillion) — and extensive clinical trial requirements — might never get developed or commercialized.

Take for example a hypothetical preventative drug for Alzheimer’s given to individuals at age 30. Because typically, Alzheimer’s develops after age 60, standard clinical trial protocols focused on clinical endpoints would prevent the drug from being developed – the 20 year patent life would be exhausted before any clinical effects could be documented.

That’s not going to work, obviously. You can see a pattern here. The free market obviously needs to government to assist with issues regarding public good. However, as anyone who’s played God knows, if you mess with one organism in the ecosystem, you can create a serious chain reaction.

For instance, looking at cancer drugs. Researchers from Harvard Law School, the University of Chicago, and MIT found that in one year – 2003 – fixed patent term distortions resulted in a loss of life-years valued at about $89 billion.

Wow! So what are we going to do?

Fortunately, the research quantifying these distortions also offers a glimpse of the path forward. Generally speaking, the commercialization lag is minimized when drugs are approved based on “surrogate” (non-mortality based) endpoints.

The researchers claim that all FDA-approved cancer prevention drugs, which would suffer from under-investment, were approved using surrogate endpoints or through publicly-financed trials.

Surrogate endpoints — e.g. molecular changes like the level of the HIV virus in the blood to physical measures like tumor size — tend to shorten the FDA approval process significantly. This reduces the cost of clinical trials. But, to expand the use of surrogate endpoints — especially beyond cancer and HIV — requires significant reform at the FDA.

And, looking further, even if you get rid of the commercialization lag, the high prices of some drugs would still be an issue.

$100,000 cancer drugs, even if developed, can become a substantial cost burden even for some Americans with otherwise generous insurance coverage.

The ACA’s annual out of pocket limits might help — to some extent — but by mandating coverage of many benefits, the ACA also puts increased upward pressures on deductibles and co-pays. This includes high cost medicines.

This is the EXACT opposite of what we fight for in Direct Care. Routine, one-off costs, should be paid out of pocket, while large costs should be exactly what is covered by insurance.

This would be addressed — and avoid innovation-killing price controls — through a tactic initially pioneered by (now) Harvard economist Michael Kremer and endorsed by George Mason University economist, Tyler Cowen – patent buyouts. Here, the government could purchase patents of approved drugs from companies and place them in the public domain, immediately making the drug generic.

Interesting, right?

According to Kremer, patent buyouts would eliminate much of the monopolistic distortions inherent in all patents, without dampening incentives to innovate.

Of course, this is all easier said than done. Over the long run we still need to innovate miracle drugs, for the people who need them the most.

Read more about the implications of patent buyouts on Forbes Apothecary