The United States spent $457 billion on prescription drugs in 2015, nearly 17 percent of total healthcare spending. The Department of Health and Human Services estimates this figure will grow to $535 billion by 2018.
Bringing a new drug to the market is notoriously expensive due to research and development, time opportunity costs, and jumping through hoops for FDA approval. Avik Roy, president of the Foundation for Research on Equal Opportunity, found that the clinical trials phase accounts for 90 percent or more of a typical firm’s development cost, which has drastically increased in recent years.
The FDA approval process has a high potential payoff at an extremely high risk, which discourages the development of new drugs. Patented drugs have only a five- to seven-year period of market exclusivity, lower than for other patents. This shorter period opens the market for generics and lower costs to consumers, but it also lowers the return to investment.
Once the patent has expired, other firms are allowed to copy the drug, subject to FDA approval. A recent working paper from the National Bureau of Economic Research by MIT professors Ernst Berndt and Stephen Murphy, and University of Chicago professor Rena Conti, finds that competition among generics is insufficient and contributes to high prices. The paper illustrates some of the underlying causes of this upward trend.
The professors find that prices for prescription drugs are rising -- and not only in isolated cases of price gouging such as Turing Pharmaceuticals former CEO Martin Shkreli’s audacious overnight price escalation of Daraprim from $13.50 to $750 per pill. Daraprim’s patent expired decades ago, but it did not have a competitor. However, prices are rising across all generic markets.
Since 2013 the number of entrants into the generic pharmaceutical industry has declined, but the number of exits has grown. The number of entrants is greater than exits, but the two groups are converging.
The decline in generic manufacturer entrants into the market is correlated with the enactment of the Generic Drug User Fee Amendment in October 2012, which requires generic firms to pay up to $273,000 per year depending on their classification. Large firms have no problem paying these fees, but many manufacturers of generic pharmaceuticals have avoided the market because they are too small to afford this large, fixed startup cost.
Since 2007, the median number of generic manufacturers for a particular drug has dropped to two. Most notably, approximately 40 percent of generic prescription drug markets have only one manufacturer.
In light of these new findings, recent initiatives taken by the FDA are promising. FDA Commissioner Scott Gottlieb, a physician and academic, has written extensively on the subject of pharmaceutical markets. As the FDA commissioner, he has power to bring back competition, and has already begun in the following ways.
The FDA released a comprehensive list of off-patent, off-exclusivity drugs that do not have a generic competitor. The agency’s hope is that generic companies will notice the opportunities and enter the market. The list will be updated every six months.
Additionally, the FDA released a policy initiative to expedite the review process for generic manufacturers in markets with fewer than three approvals for competitors, removing a significant portion of the barrier to entry in the industry.
According to the IMS Institute for Health Informatics, the entry of a generic company into a marketplace reduces the price of a drug by 51 percent within the first year. By the fifth year, the price drops by 77 percent.
With the U.S. prescription drug expenditures at $457 billion, generic competition among even a quarter of the off-patent single-provider drugs would translate to billions of dollars saved annually, given that two out of five of these drugs are provided by one generic manufacturer.
Dr. Gottlieb has also plans to capitalize on new opportunities created by the 21st Century Cures Act. This allows the FDA, among other things, to accelerate the development of high-demand novel drugs, and authorizes the FDA to incorporate new technologies in order to modernize their clinical trials and assessment methods.
As the FDA’s drug approval process becomes more efficient, the cost of developing a new drug will likely decline, encouraging companies to invest in new drugs.
The FDA must strike a balance between promoting branded firms to innovate while also encouraging competition from generic companies to increase affordability. Scott Gottlieb wants to expand innovation and competition. Prescription drug markets need to be both competitive and conducive to innovation in order to lower the cost of health care and increase accessibility.
Charles Henderson is a contributor to Economics21.
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