In the current issue of Regulation magazine, I have a review of two books, Overdose, by Richard Epstein, and Leviathan's Drug Problem, by John R. Graham. Both are excellent. Although Epstein's book came out in 2006, it didn't make much of a splash. More's the pity, because it's full of insights. Some excerpts from my review:
Take the old bromide about how advertising and marketing costs of drugs increase the price that drug companies must charge. Seems obvious, right? It is also incorrect, and Epstein effectively explains why. He points out that the cost structure in the pharmaceutical industry is extreme: high fixed costs--potentially in the hundreds of millions of dollars--to produce the first pill that can be legally marketed, but then low marginal costs for subsequent pills. Without large expenditures on marketing, the market will be too small to generate enough revenues in excess of variable costs to cover the fixed costs. Drug company executives, looking forward and seeing this fact, will not develop new drugs. And a nonexistent drug has, in effect, an infinite price. But if spending this money on marketing can multiply the size of the market, then the expected revenues will be enough to make developing the drug worthwhile.
Epstein uses a numerical example to clinch this case. Assume, he says, that a new product costs $1 million to produce; thus, without marketing, it must sell at least 10,000 units at $100 per unit. But assume further that at that high $100 price, only 8,000 people want to buy it. Revenue to the firm: $800,000. Result: the drug does not get produced. But now assume that for an additional $200,000 of truthful and accurate advertising (in a separate chapter, he handles ads that are not in this category), the firm can sell 100,000 units at $20 a pop. The result: the firm makes revenues of $2 million. Assuming that its variable costs are $500,000, the firm will net $300,000. The drug has been produced, and marketing has made its price fall from infinity to $20. Scale up these numbers
by a factor of 100 (except for the price) and you have a fairly plausible, possibly even common, scenario in the drug industry.
Also, as I point out in the review, the Vioxx discussion alone is worth the price of the book. I write:
Indeed, had I written the book, I would have led with this discussion because it shows just how dysfunctional the liability system is and how the New England Journal of Medicine, in particular, helped set up Vioxx's producer, Merck.
Graham's book is excellent too. One excerpt from my review:
He quotes the finding of the Abigail Alliance for Better Access to Experiment Drugs--which consists of families who have lost loved ones who were prohibited from taking experimental drugs--that every drug for which it advocated use as an experimental drug was later approved by the FDA.
Graham goes on to advocate competing drug approval organizations on the model of Underwriters' Laboratory or, failing that, allowing any drug to be sold in the United States if a regulator in any other developed country has approved it. Bottom line: monopoly is a bad idea.