David R. Henderson  

How FDA Regulation Stifles Drug Development

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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.

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CATEGORIES: Regulation

COMMENTS (10 to date)
david writes:

Link to "current issue" is bad.

From the excerpt, seems to ignore that much advertising is between a few similar drugs targeted at the same demographic - Lipitor vs Zocor, etc. Epstein's dynamic seems empirically testable by observing what happens when similar drugs enter the market. Do you know of any such studies?

Wikipedia's account of the Vioxx recall seems to favor NEJM, although I suppose Wikipedia is full of pinko commies...

I'm not sure how competing drug approval organizations would resist payola, which (judging from previous incidents) seems easy enough to hide for substantial periods of time. Presumably some set of institutional rules would be required. Permitting patients to sign waivers seems like an interim solution. The concern has often been that consumers are really, really, really bad at judging what is medically sound; unless the good Mr. Henderson wishes to defend the wonders of chelation therapy, homeopathy, and other numerous up-and-coming industries, this seems fairly undeniable.

Rebecca Burlingame writes:

Too bad that someone, anyone, can't convince the FDA to just communicate with other countries who approve drugs and therefore stop some of the ongoing gridlock and inefficiency.

Mark S writes:

I am interested in what you mean by saying that the New England Journal "set up" Merck.
The FDA has always been sluggish, but in some other countries there is a bit of cheerleading for indigenous producers. The clinical trials are often underwritten by the pharma houses, and regulators are vulnerable to capture by the industries they are supposed to regulate. Japanese drugs seem to perform less well when tested in the larger world.
Vioxx seem to me a poor basis from which to critize the FDA. It does very little that other NSAIDs don't do. Aspirin is pretty much as effective, does not cause heart attacks, and costs ~1% as much. Thalidomide might be a good example of areas where the drug approval process could be improved. While we need to give the regulators credit for the fact that delayed US approval prevented the phocomelia babies of the Sixties in the US, we need to recognize that current regulations help keep the price of the drug at around $100 per pill.

David R. Henderson writes:

@Mark S,
To satisfy your interest in the Merck story, read my review. If that doesn't satisfy your interest, read Epstein's story. It's fascinating.
Also, on Vioxx re aspirin, you didn't do the whole comparison. For many users, you're right, and Merck appears to have way oversold the drug. For a substantial percent of users, Vioxx was much better because of the side effects they avoided.

Dan Weber writes:

Instead of the FDA giving a thumbs-up or thumbs-down, it ought to provide a calm listing of risks and benefits.

If something halves my rate of heart attacks while doubling my rate of brain cancer, maybe that's a good idea for me. Or maybe not.

rwb writes:

The German government did a study on prescription pharmaceuticals and found that only one percent had efficacy of which most were old medications. This would seem to be supported by our not having good outcomes and the more we spend the more ill society seems to get. It seems that antibiotics and pain killers both physical and psychic float the industry.

Is most of the pharma market pure placebo or marketing? Is there something wrong with the basic approach or is it running out of steam especially relative to newer approaches like stem cell. It does seem that drugs are cheaper elsewhere so where is the extra margin coming from. Maybe the patent process for pharma is broken and what needs to happen is massive government research with no company ever getting an exclusive but the results being released generally. Maybe its better policy to defund pharma and focus on nutrition and reduction of toxin load.

Our health care isn't that great as the health of our people is failing relative to other nations. The average American dies of cancer/heart attack/stroke where there are 3rd world nations with almost none of this. The answer cannot be in conflating acceptance of the actual care with people being held hostage by huge inflexible rate increases and open enrollment policies.

The insurance industry cannot be allowed to gamble and then pass along the cost and the risk. Pharma has to be subjected to prevention. These will reduce cost and yield better health both of which will help the real socially useful economy.

Tom West writes:

I strongly suspect that the reason that the FDA is the way it is primarily because that's the way the populace wants it.

It would be interesting to make substantive changes to the system along the lines recommended by David Henderson and see how many years it would take before public interest (roused only when there's a failure) forced politicians to gradually remake the system into a clone of what we have now.

We are not a culture that, if it's somebody else's responsibility, accepts that sometimes bad things happen. Politicians who are deaf to the population's need to "do something" when a tragedy occurs don't remain politicians for long.

topgun writes:

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

There is a big problem with this approach. Drug companies would simply go to and pay the organization that is most lax when it comes to testing. Hence the competition between the approval organizations will become nothing more than a race to the bottom for testing standards. The conflict of interest here is obvious. We've already seen this model with ratings agencies. The agencies had an incentive to give AAA ratings to securities sold by the banks even when they didn't deserve those ratings. There were numerous instances of the ratings agencies 'massaging' the results or 'tweaking' the model to achieve the desired result. If they did not, they'd lose the bank's business. We all know how that worked out.

Pre-approving a drug in the US because its been approved in other countries also faces exactly the same problem. The way we have tax havens nowadays, there'd emerge 'drug testing and approval' havens for the countries with the most lax regulations.

Thomas Sewell writes:

Worried about drug results in an FDA-less country?

Require companies to post an insurance bond to pay possible claims if the drug turns out to be bad. Insist on a transparent process via a third-party provider that is sufficiently underwritten, just like current insurance underwriting works.

At that point, people and Doctor's can compare how much that third-party provider charged the drug company to insure the drug and do a quick proxy risk calculation accordingly.

If a company can make a convincing case that their drug is safe enough to avoid claims to their insurer, then it'll be a quick approval process and be on the market quickly.

If it's a dubious and/or highly risky drug, their insurer is going to be incentivized to either require a lot of extra honest studies to prove it's safe or pay a lot more money to offset the risk of claims.

If you insist on government involvement in the drug market, at least align the incentives for the participants with something more useful than the FDA's current "Don't ever approve a drug that has any chance of harm, no matter how much good it would do!"

More on the FDA at Come Let Us Reason Together.

Tom West writes:

If you insist on government involvement in the drug market, at least align the incentives for the participants with something more useful than the FDA's current "Don't ever approve a drug that has any chance of harm, no matter how much good it would do!"

Why? I think the populace has made is *abundantly* clear that that is exactly what they desire. Try publicly espousing "sometimes people have to die for the good of the many" and watch your political career come to a messy end.

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