It might seem odd to ask whether any large private industry—automobiles, say, or computers or agriculture or even legal services—could simply be replaced by a public enterprise. There was a time, of course, when socialists proposed to do that with many industries. Even otherwise capitalist nations occasionally socialized what Lenin called the “commanding heights” of market economies. The United Kingdom comes to mind. After World War II, the UK confiscated the steel and coal industries among others, took over virtually the entire healthcare system, and extended the government broadcasting monopoly from radio to television. Many Western European nations followed suit to varying extents. But the last three decades have seen just the opposite: mammoth, bold, and at times politically courageous moves to privatize what had once been public, even those longstanding monopolies in broadcasting and telephony. Despite much griping about “privatization” and “deregulation,” there is little political pressure to reverse course. On the contrary, mass privatization is a hallmark of the stupendous leap now taking place as China and India and many other poverty-stricken nations transition from “undeveloped” to “rapidly developing.” 

It is all the odder, therefore, to hear serious proposals to cripple or even dismantle one of our most crucial for-profit industries—pharmaceuticals—and replace at least part of it with government and nonprofit enterprise. Some of the attacks are familiar. Pervasive price controls, for example, have been implemented in most economically advanced nations other than the United States. Price controls are usually the death knell of innovation, whether the products are high-tech or the seemingly mundane, such as apartments. But pharmaceutical innovation has been kept alive by profits from the mammoth, uncontrolled U.S. market. The more adventurous firms and products simply find their first home in the United States, before they scoop up whatever profits they can find abroad. A recent study comparing the U.S. Food and Drug Administration to the European Medicines Agency (which approves the European Union’s drugs) found that the EMEA is just as quick if not quicker to approve new drugs, but between 2000 and 2005, almost three times as many new drugs were first approved in the United States compared to the European Union. We can expect a political battle over U.S. price controls, starting in the states and with proposals to expand the role of Medicare, Medicaid, and the Veterans Administration, all of which control prices to some extent. 

Pharmaceuticals, more than virtually every other industry, rely upon patent protection.

But price controls are not the only way to undermine a research industry. Another method is to weaken patents. Pharmaceuticals, more than virtually every other industry, rely upon patent protection—first, during the difficult years between discovery and FDA approval (if that elusive goal is even reached), and then for five or ten years after approval when profits can erase the costs of drug development. One way to undercut patents is to implement compulsory licensing, where the government confiscates a patent in return for a fee that is set, of course, by that same government. It is disconcerting to see so-called middle-income nations like Thailand and Brazil implementing compulsory licensing of drugs to treat HIV, cancer, and other illnesses. This jarring development has been cheered on by the World Health Organization and some usually sensible medical journals. Even in the European Union and Canada, we may see compulsory licensing when government-funded healthcare systems are required to purchase an expensive drug that faces no close competition. 

Also on the table are proposals to break the drug patent system into pieces, leaving only part of it to underpin drug R&D. One such idea comes from Senator Bernie Sanders, the only avowed socialist in Congress, who happens to represent the traditionally very nonsocialist state of Vermont. Sanders has introduced the “Medical Innovation Prize Act of 2007.” If this legislation becomes law, a pharmaceutical patent would be confiscated by the federal government when the patented drug is approved for marketing by the FDA. The firm that developed the drug would receive compensation—a “prize”—at a level to be determined, of course, by a government-appointed committee. The law’s effect would be to reduce the pharmaceutical industry to a torso of its former self. 

The goal of the law would be to harness private incentives to develop drugs and then turn marketing, distribution, and pricing over to the public sector. This would have two effects, only one of which is obvious. The obvious one is the fact that the financial payoffs from drug development would be set not by willingness to pay in the marketplace but by a government agency with an interest in restraining costs. That would translate into short-run savings and a long-run dearth of innovation. The second and far less obvious effect would be even worse. The Sanders plan would remove incentives from the most crucial part of modern pharmaceutical research. We are today in an era of “targeted therapeutics,” including amazing biotech drugs like Avastin for cancer and Enbrel for rheumatoid arthritis and Rituxan for cancer, rheumatoid arthritis, Crohn’s Disease, and multiple sclerosis. As it turns out, most of the value in R&D comes from the search for new and better uses of approved drugs. The real advances come as clinical trials move from one cancer to another, from one immune-based illness to another, and so on. This means we need expensive, high-risk research for many years beyond initial FDA approval. 

The most profitable drug in history is Lipitor. But it barely survived the winnowing-out process when it was still in development. An unexpectedly good result in a trial saved it.

Another equally destructive idea comes from longtime industry critic Marcia Angell. She wants the industry to fund clinical trials of new drugs (before and after FDA approval), but with academics directing the research instead of pharmaceutical firms. Such a division of authority and responsibility—one party pays, another one spends—would be disastrous. The firms’ only goal is to supply evidence of drug safety and efficacy that is persuasive to the FDA and, most importantly, to patients and their doctors. Academics, no matter how public-spirited they think they are, will pursue their own agendas, which can range from cost control to personal biases in drug treatment. That’s one reason the massive headline-grabbing drug trials mounted by the federal Agency for Healthcare Research and Quality have had surprisingly little impact on clinical practice. 

Where are all these ideas coming from, especially the newer ones involving prizes and such? To some extent, they are the inevitable byproduct of the political forces that promote healthcare as a “right” and have brought socialized healthcare to many nations. Nonetheless, the oldest and most reliable sources of industry attacks and radical proposals are drug prices and industry profits. Drug prices are far above the costs of production. This is absolutely necessary in any industry in which huge development costs are borne upfront by sellers and recouped later through sales of millions of individual items. Think about DVDs, CDs, computer software—and pills. All very logical, but the high prices grate, nonetheless. So do profits. Again, this is inevitable. Most drug development fails. Most molecules prove useless as soon as they enter human testing and most of the rest fail later on after millions or hundreds of millions of dollars have been spent on clinical trials. Success is always a long shot but it does arrive occasionally, sometimes in spectacular fashion. The most profitable drug in history, perhaps the most profitable product of any kind, is Lipitor, Pfizer’s cholesterol-reducing drug that in recent years has achieved the highest sales of any drug in the world. But Lipitor barely survived the winnowing-out process when it was still in development. Only an unexpectedly good result in a clinical trial saved it. Lipitor survived and went on not only to generate profits but also, after a series of clinical trials, to help revolutionize understanding of coronary heart disease and heart attacks. 

Spectacular success brings spectacular profits. Again, this is the only way this industry can work. But that doesn’t mean profits are inordinate on average. Economists who have sorted through the mysteries of accounting in this strange industry have concluded that on the whole, pharmaceutical industry profits have been more or less what one would expect when so much has to be invested at high financial risk. 

If we really had a reliably productive government-nonprofit drug development system, we should have seen its fruits by now.

But beyond prices and profits lie two other worrisome lines of attack. One is essentially the “what-have-you-done-for-me-lately” argument. Despite the wonders of the cholesterol-reducing statins and a slew of new cancer drugs, a common charge is that the industry simply hasn’t given us much in the way of useful new drugs in the past decade or so, notwithstanding all those profits and the hundreds of billions of dollars invested in R&D. Although this indictment is brought with such distressing frequency as to become almost commonplace reasoning (it is in the “findings” at the start of Sanders’s patent abridgment bill), it is deeply mistaken. I pursued this point at some length in an earlier article (“The Golden Age of Medical Innovation,” The American, March/April 2007). ’Nuff said on that matter, I suppose. But what was true a year ago is even truer now, when the latest results for the breast cancer drug Femara (another one of those targeted therapeutics) has just been shown to cut the recurrence of breast cancer as long as seven years after initial treatment. 

The second criticism is more subtle, and it comes straight from the gulf between prices and marginal costs of production. Lipitor, for example, costs roughly 6 cents per pill to manufacture, and public sources indicate it is sold at retail for about $2.70 per pill. The disparity between price and marginal cost raises a problem in economic efficiency, one that has been analyzed and debated at least since the 1930s. The bugaboo that haunts economists is “deadweight loss,” which occurs when a product that would have granted benefits greater than marginal costs (“social costs”) was not bought because it was priced at more than those benefits. Think about folks who would gladly pay 50 cents for a pill that costs a nickel to manufacture, but don’t take the pill because its price is a dollar. When you consider the billions of pills taken by millions of patients every year, these tidbits of deadweight loss could add up to very large numbers. 

The odd thing is that in the United States and other advanced economies, the deadweight losses from non-marginal-cost pricing are probably pretty small. That’s because the big payers (who purchase the bulk of all branded drugs sold) have ways to rationalize the whole process, using a variety of techniques that basically resemble a software site license where the cost of adding one more user is pretty small. 

Nonetheless, the price-versus-marginal-cost problem is one of the intellectual justifications for “prizes” and patent abridgment, at least in wealthy nations. Senator Sanders, for example, sees his plan as providing a prize for successful R&D even though the patents that motivated the research get confiscated when success is first achieved. (For poor nations, Harvard University economist Michael Kremer and others have proposed various types of prizes, sometimes in the form of guaranteed purchase funds for successful drugs, to deal with the fact that poor nations do not offer sufficient demand to induce the development of new drugs for malaria, tuberculosis, and other tropical diseases. See Kremer and Rachel Glennerster’s book, Strong Medicine: Creating Incentives for Pharmaceutical Research on Neglected Diseases, which is full of useful insights on drug development in these difficult circumstances.) 

As long as antibiotics have the same patent life as other drugs, we can expect a scarcity of entirely new drug classes. We’ve had only two in the last 50 years.

Now we get to the heart of the matter. Everyone—at least everyone with a smidgen of economic literacy—knows that if you simply push prices down toward marginal costs, or if you dismantle the patent system piecewise, you will cripple R&D incentives. So the second argument weaving through the debate is this: we don’t really need the overpriced and unproductive pharmaceutical industry anyway. We have the National Institutes of Health and several giant nonprofit organizations, with the Bill and Melinda Gates Foundation reigning above all, plus a raft of smaller nonprofit and government organizations throughout the developed world which are also bent upon discovering new drugs. If we can get innovation that way, it doesn’t matter if we dismantle the for-profit industry. We lose what the industry creates, but we can make that up with public and nonprofit R&D without all those costs and inefficiencies that haunt the traditional pharma industry. 

This is the point at which pharmaceutical industry critics go most profoundly astray. 

There are two problems with government and nonprofit R&D as a substitute for the traditional for-profit industry. One lies in what the nonprofit sector has not tried to do; the other lies in what it has tried to do. 

We have to remember that no laws, regulations, or traditions have prevented the public research system from inventing the drugs we need if it was really capable of doing that and no one else was. In principle, publicly funded drug research can run all the way from basic research through clinical trials to FDA approval and, if the believers in this approach are correct, it can be conducted at reasonable costs including the inevitable losses from drilling dry holes. 

But let’s look at the record. If we really had a reliably productive government-nonprofit drug development system, we should have seen its fruits by now. Those fruits would have arrived in such areas as the testing of off-patent drugs with great potential and the creation of new drugs where profit incentives are inherently weak because of inadequate intellectual property laws. We should have seen, for example, clinical demonstrations of aspirin for heart disease and cancer much faster than actually occurred. If aspirin had been under patent, its manufacturer would not have taken decades to test the much-discussed hypothesis (eventually proven true) that aspirin could prevent heart attacks. Or look at high-density lipoprotein, the so-called good cholesterol. If HDL were a new, patentable molecule, we would be reading about all sorts of publicly funded clinical trial results, perhaps showing that boosting HDL is even better than reducing low-density ipoprotein in preventing heart attacks, which is what the typical statin drug does. This was pointed out by the editorial writers at The New York Times, whose November 9, 2003, editorial concluded, “the fact that such a promising treatment was widely ignored because there was no immediate profit potential is disturbing. In theory, the nation’s great web of government-financed medical research institutions should step in to promote development of the kinds of drugs and therapy that industry regards as unprofitable. This story makes one wonder how many similar gaps exist in the vaunted American research establishment.” As it happened, Pfizer spent a billion dollars or so in a failed attempt using a patented variant of a form of HDL. Research continues in the private sector, with immense benefits if success is finally reached. 

The benefits of research on vitamins could be huge, but with no patents available for such substances, progress has come mainly from the public sector and has been very slow.

Or look at antibiotics. This class of drugs faces a natural form of market failure—not complete failure, but a very serious one nonetheless. For the best of reasons, physicians are typically urged to avoid prescribing a new antibiotic unless it is absolutely necessary. Why take a chance on incubating drug-resistant bacteria? Better to leave a new drug on the shelf except in extreme situations where everything else fails. In the best of all possible antibiotic worlds, a new drug could go for a decade or more with very little usage until older drugs have met their comeuppance in the form of drug resistance, finally making the new one a mainstay. By then, of course, patent life would be practically gone even though most of the prescriptions have yet to be written. This leaves relatively little room for profit. As long as antibiotics have the same patent life as other drugs, we can expect a scarcity of entirely new drug classes. We’ve had only two in the last 50 years. This is the perfect environment for public research. The medical establishment including the NIH, WHO, and other nongovernmental organizations around the world understand these dynamics and constraints as well as anyone. They have published dozens of books and reports on the topic. All bewail the slow pace of new antibiotics from the private sector. Again, no laws or regulations have prevented the public sector from solving this problem. But it hasn’t. The desperate search for new kinds of antibiotics continues, and what we get still comes from the private sector. 

Deserving of far more attention than it has gotten is one of the more remarkable natural experiments in drug development. The three greatest scourges of poor nations are HIV-AIDS, TB, and malaria. Two of these, malaria and TB, barely touch wealthy nations. HIV-AIDS, on the other hand, first struck in California and quickly spread into numerous pockets of the United States, Europe, and elsewhere, although its greatest toll soon came to be seen in sub-Saharan Africa. In other words, there’s a good market for HIV drugs but not for the TB or malaria drugs. Oddly enough, HIV is a far more difficult pathogen to deal with than those causing either malaria or TB. In fact, this virus is truly extraordinary in its protean and elusive nature in the human body (and there is no other animal host). In the first decade or so after HIV was identified and its properties began to be explored, few drugs of significant value were brought to market, the most notable being AZT (zidovudine), which was essentially a failed cancer drug. 

Economists have concluded that pharmaceutical industry profits have been more or less what one would expect when so much has to be invested at high financial risk.

In 1995, however, the first protease inhibitor, Invirase, appeared, followed by more drugs in the same class, plus a new class introduced in 1996 by Viramune, which again was followed by several more drugs in the same class. These drugs brought a revolution, transforming an illness that was fatal nearly 100 percent of the time into something that for years, even decades, can be managed as a chronic disease. In a remarkable excursion through piles of data, economists Tomas Philipson and Anupam Jena, both of the University of Chicago, calculated that increased survival from HIV drugs generated nearly $1.4 trillion in economic value in the United States alone. The firms that created and sold the drugs have captured only about 5 percent of this. It’s a wonderful example of how competitive innovation in a very high-risk line of research can generate value greater than almost anyone would have predicted. Amazingly, this episode is not over. A spate of new drugs—led by Merck’s Isentress, the first integrase inhibitor, and Pfizer’s Selzentry, the first co-receptor antagonist—are bringing two new therapeutic classes to market just in time to save patients whose immune systems can no longer handle HIV despite the protease inhibitors and other treatments. 

During the same years, the age-old TB scourge continued, with millions of patients seeing essentially no new treatments at all for decades—the standard treatment involves a combination of drugs that first appeared around 1960. The fight against malaria is doing only slightly better, with a few new drugs coming, again, mainly from private firms for whom malaria drug development is largely a sideline. Most of the progress on this front is against the disease vector—a certain kind of mosquito, which can be stopped with insecticides and bed nets—exactly where the battle has raged for a century or more. 

The lesson here is that no matter how great the need in poor nations, the government and nonprofit sectors have never accomplished very much compared to what the private  sector does when there is serious money to be made. 

Also instructive, however, is what happens even in rich nations when the most essential ingredient to pharmaceutical R&D—patents—is missing. Here, one story revolves around micronutrients such as folic acid and its relatives, and vitamins B, C, D, and E. The potential benefits of research are huge, but with no patents available for such long-known substances, progress has come mainly from the public sector, and it has been slow indeed. 

For example, researching the strongly suspected connection between folic acid and the prevention of birth defects took decades before the connection was proved and utilized. Progress on other enticing topics—such as the role of folates in cardiovascular disease, vitamin D in cancer, and the so-called “good fats” such as omega-3 fish oil—proceeds at a snail’s pace. 

And ethanol (the alcohol in beer, wine, and spirits) may be a potent heart attack preventative, partly because it raises HDL, which appears to cut heart attacks. But while research on alcohol and heart disease has been in the works for several decades, little progress has been made toward a definitive answer on what alcohol can do and how its benefits could be realized. 

So much for what government-nonprofit research has not tried to do. Now let’s look at what happens when it does try to do drug development. Part of this consists of NIH-style basic research, conducted in-house or, more commonly, through grants and contracts to academics and others. Measuring the efficiency of this kind of research is extraordinarily difficult. Let it suffice to say that whatever debate there is tends to focus on whether we should spend even more and whether the monies can be distributed more effectively.  Hardly any drugs have proceeded all the way through large-scale clinical trials and FDA approval and reached market based only on NIH-sponsored research. Although there are proposals to create new government agencies dedicated to drug development, there is little reason to expect different results. 

Risk-taking, year after year and decade after decade, is bound to bring far more failure than success.

Two other sources of government drug development merit attention. One is Department of Defense R&D, a massive effort that occasionally ventures into the development of needed drugs that are not coming from the private market because the DOD market is very small or is deemed unreliable (perhaps because large sales will not come unless an unlikely emergency arrives and/or Congress can be persuaded to appropriate funds for just this purpose). Although most attention focuses on the extraordinarily expensive vagaries of weapons contracting, the less attended efforts to develop drugs and vaccines have generated relatively little of value. 

Finally, another part of the record consists of the emerging experience in biodefense drug development following the dissolution of the Soviet Union (with the discovery of a vast biological weapons program), the September 11, 2001, terrorist attacks, and the still unsolved anthrax case of October 2001. We should pay close attention to the unfolding story of BioShield, the $5.6 billion program of drug-development-by-contract created in July 2004 to be run by the federal government. The goal is precisely to harness public monies and leadership to create drugs that are unlikely to come from the private sector because profits are too uncertain. Running alongside were less structured efforts by the NIH, especially the National Institute for Allergy and Infectious Diseases, which focuses on vaccine research. The result so far has been largely disappointment and delay, with the best private-sector talent opting out of the inevitable bureaucracy and politics of government-directed research. The story is encapsulated in a depressing series of media reports. Consider some of the headlines from newspapers, journals, and government reports: “No Hope for Stockpile of New Anthrax Vaccine by November” (The Washington Post, March 17, 2006); “Bid to Stockpile Bioterror Drugs Stymied by Setbacks” (The New York Times, September 18, 2006); “Bioterror Antidote: Unfilled Prescription: After Four Years, Scant Progress on Bush’s BioShield Plan” (The Washington Post, January 16, 2007); “Project BioShield: Actions Needed to Avoid Repeating Past Problems with Procuring New Anthrax Vaccine and Managing the Stockpile of License Vaccine” (Government Accountability Office, October 2007). 

It is one thing to know that the pharmaceutical industry has been indispensable—so far—but it is quite another thing to understand why that is so. Part of the story, of course, is a record of success where government and nonprofits have failed. But, paradoxically, the failures in the private sector are just as important. Drug development is an endeavor where success is practically never achieved without large-scale financial and scientific risk-taking. But risk-taking, year after year and decade after decade, is bound to bring far more failure than success. The absorption of the lessons and losses offered by failure lies at the core of the pharmaceutical industry’s record of creating extraordinary medical tools. When Merck suffered four late-stage drug development failures in a single year, and Pfizer abandoned its torcetrapib HDL-boosting drug after spending a billion dollars on research, the losses were absorbed by those firms and their stockholders, not taxpayers. The firms reallocated resources and moved on without being dragged down by researchers and other stakeholders who would have liked to persist in failing research agendas, something that has plagued publicly funded research on the elusive HIV vaccine. There is no reason to expect that this research model—the indispensable model—will ever be successfully followed by the public or nonprofit sectors.