November 16th, 2005

Brad @ Burning Man

Prescription Drug Pricing, The Unasked Questions

So, in light of yesterday's summary ...

Hey, Wait a Minute! For the whole duration of the pharmaceutical research boom, we've had a 100% refundable Research and Development tax credit. For those of you who don't know the difference between a tax deduction and a tax credit, a tax deduction reduces the amount of your income that's taxable. All business expenses are tax deductible; that is to say, companies pay tax at their normal rate on their total revenues minus their total expenses. The argument has always been that revenues minus expenses is the definition of "income" in the sense that you and I mean it, when applied to companies. But tax credits are an entirely different animal altogether. A tax credit means that the government is volunteering to reimburse you, after the fact, for 100% of that expense. (In most cases, that's "up to a certain cap per year.") So all that pharmaceutical research that's supposedly being paid for out of the profits on drugs with current patents? Aren't we paying for that twice, once out of the US Treasury in the form of tax credits, and then a second time out of our wallets or insurance payouts?

But maybe I'm wrong about how that works. So let me go on to a more important question ...

Are We Still Getting Our Money's Worth? What do Schering Plough, Merck, Eli Lilly, and Bayer all have in common? All of them have had their stocks battered in the last couple of years for the same reason. In all four cases, investors were counting on them continuing to crank out new drugs fast enough to replace the revenues on their older drugs as the patents on them expired. And in all four cases, the pace of innovation, the rate at which new and successful drugs are being discovered, has slowed significantly.

The major scientific innovations that lead to the pharmaceutical revolution are now older than some of you are. hick0ry tells me that there are ongoing scientific discoveries that may soon lead to the discovery of whole new classes of drugs. Maybe. But those discoveries aren't much more than theoretical now, way more tentative than (by comparison) molecular modeling was when when the research took off on receptor-site binding compounds. If you don't find that interesting, consider this possibly related fact. Look back over the last couple of year's worth of new-drug patents. How many of them were for completely new drugs, as opposed to trivial refinements of existing drugs? Making Prilosec time-release may improve quality of life for Nexium users, but is it new science? Because we don't understand enough about how selective serotonin re-uptake inhibitors work, it was definitely worth it to tweak those molecules very slightly in hopes that of finding one that would do a better job of fitting in with each depressed person's receptor makeup. But compare that to the original breakthrough of the discovery of SSRIs, and you can see that we're talking minor engineering, not major scientific discovery.

So isn't it starting to look as if we're reaching the point of diminishing returns? What if all the "low-hanging fruit" from the last scientific breakthrough have already been "picked"? It's already looking to me like we're shoveling larger and larger sums of money into less and less productive research, and that's the very definition of diminishing returns. And if what we need to kick off another explosion of new drugs and new medical techniques is another major scientific breakthrough ...

Are Corporations the Best Place to be Investing that Research Money? Corporations don't innovate, especially not successful ones. An innovative product means cannibalizing the sales of an existing product for one whose R&D costs haven't been paid off yet. Innovation by definition means lower net revenues than continuing to make money off of the old product. That's probably at the top of the long list of reasons why, throughout all of history, hardly any major scientific innovations have come out of corporate R&D labs. Historically, real scientific innovation comes out of two places. Most of it comes out of universities. A tiny amount of it, but more than ever came out of any corporation, comes out of big-bucks government and military projects. But even then, when the government needs researchers to develop some essential breakthrough, whether atomic fission or the graphical user interface, they don't hire people with corporate R&D history. They hire university researchers.

Real scientists, as opposed to corporate scientists, aren't competing solely for the approval of their bosses. They're competing to impress each other. They're competing to impress the pool of graduate students that they recruit their volunteer/slave labor from. And most of all, they compete to impress the Nobel Prize committee, the MacArthur Genius Foundation prize committee, and for similar prestige awards. Right of first publication almost certainly is more valuable to your average scientist than a 10% performance bonus, because right of first publication gets him the stuff that he really wants. No increase in his salary will get him the respect it takes to get to run his own lab without having to answer to grant writers or administrators. No pay raise to him will cover the university's cost if they want to buy the Really Cool equipment that he wants to work on. No performance bonus that he gets will help him attract the best and the brightest among the grad students so he can feed on benefit from their insights skilled assistance. And what's more, when it comes to benefiting society, university research's incentives run the right way, not the wrong way. Corporate scientists have powerful economic incentives to keep their research secret, where society won't benefit from it until the corporation finds a way to profit from it, so their competitors can't build on that research and leap-frog them before the product comes out. University scientists, however, are rewarded in order of publication date, so when a university scientist makes a discovery, he has every incentive to rush it into print, where other scientists can benefit from it and build on it, lest someone else beat him to publication.

I've got one more big-picture question, but I'll save that for tomorrow.
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