It’s no secret that transatlantic relations have been a bit stormy recently, due in part to President Trump disparaging European countries as “freeloaders” who invest comparatively less in research and development for new medicines while suppressing drug prices through government controls.
Nor is it surprising that Europeans have taken exception to his belligerent tone. But pundits on both sides of the Atlantic should note that an altogether calmer American politician, the respected Sen. Orrin Hatch, R-Utah, is making the same point, albeit with less inflammatory language. Innovation reduces the cost of medicines by fostering competition, but price controls hinder this process.
The U.S. is the world’s primary source of research and development for new drugs. According to the European Commission, America spent €61B on pharmaceutical R&D in 2016 — about 46 percent of the global total — even though the U.S. represents just over 4 percent of the world’s population and just under a quarter of global GDP in nominal terms. The overwhelming majority of this innovation is privately funded, and research has revealed a strong correlation between drug companies’ profitability and R&D spending: The more money they take in, the more they invest in innovation.
But in Europe, innovators are subject to arbitrary price controls, instituted by national governments more interested in rationing and keeping drug prices artificially depressed than in finding new cures. Thanks to measures like price caps and compulsory rebates, on average the 31 members of the Organisation for Economic Co-operation and Development spent €474 per capita on prescription drugs in 2015, compared to €750 in the U.S. Once again, because of the strong link between income and innovation, that means less money for new cures: While the U.S. drug industry spent €199 per capita on R&D in 2014, for the European members of the OECD the figure was just €47 per capita.
Ironically, these market-distorting interventions actually help prop up drug prices in the long term, by stifling the only reliable means of lowering them through real economic forces: innovation and competition.
A number of studies have shown that pharmaceutical R&D results in lower drug prices by spurring competition. Since patents cover specific molecules but not the natural biological processes they interact with, following the discovery of a new drug rival companies have every incentive to develop drugs which exploit the same process — often offering additional benefits, such as greater efficacy or tolerability — thereby forcing down the price of the first drug, even while it remains under patent protection.
One study of twenty new “follow-on” drugs found that 80 percent launched at a discount relative to the first drug, with an average discount of 26 percent. Another study identified discounts of 21 percent to 61 percent for seven major “follow-on” drugs launched in recent years. Regulators from the European Medicines Agency confirmed that in some cases “availability of these products can drive down prices almost as much as the availability of generics,” citing the example of follow-on drugs for hepatitis C, with eight new competitors forcing price reductions of 40 to 65 percent in just a few years.
This process happens very quickly. The time needed for competitors to develop a “follow-on” drug plunged from 10.2 years in the 1970s to 1.2 years in the 1990s, while the period of “marketing exclusivity” fell from 8.2 years to 1.8, yielding price reductions with remarkable speed, and without the need for price controls or tampering with patents protections.
Crucially these price reductions were not the result of government fiat, but rather the product of market dynamics that allowed innovation to flourish. As such they will extend to every healthcare system in the world, provided free market principles are allowed to operate. Transparent pricing policies, strong protections for intellectual property, incentives to innovate — these are the lodestars that should guide American trade representatives seeking fairer trade terms in bilateral negotiations with the United Kingdom, the EU, and other trade partners.
According to a new study supported by the World Economic Forum and the MacArthur Foundation, eliminating price controls in OECD nations would increase global pharmaceutical R&D spending by 9 percent to 12 percent, producing 8 to 13 new drugs per year and extending the average lifespan of a 15-year-old living in these countries today by around a year.
Lifting drug price controls would also help restore Europe to its rightful place as a leader in scientific innovation — a role it forfeited in the 1990s, not coincidentally at the same time price-controls became widespread. This is not just a matter of pride, but economic good sense: European champions, currently constrained by price controls at home, would be unshackled, boosting R&D investment and creating tens of thousands of new jobs through direct and indirect employment networks. Setting aside the enormous potential gains in health and wellbeing, it seems perverse that the EU, with a population over 50 percent larger than the U.S., should employ 14 percent fewer people in its pharmaceutical industry, with less than half the value added per employee.
While American politicians are understandably focused on lowering drug prices at home, this issue is important for Europeans too. Arbitrary government interventions have distorted our markets for too long, sacrificing medical advances, depressing economic growth, and ceding scientific leadership. Europeans have paid a steep price, trading long-term progress for short-term savings, and now we are headed in exactly the wrong direction, threatening to further reduce incentives for innovation and competition in the pharmaceutical sector. It is time we faced reality and let the markets do their work — even if that means admitting Trump was right.
Pietro Paganini is an adjunct professor at John Cabot University in Rome and at Temple University Fox School of Business, and president of Competere, an Italian think tank committed to advancing innovation and sustainable growth.
