Drug Prices, Stocks and the Democratic Win

Greg Mankiw points to some interesting data on the price of stocks for Big Pharma.

drugcompanies.gif

While overall the stock market was up, the stock price of these big pharamceutical companies took a hit? Mankiw’s interprets this data to mean that the Democrats are going to do something about drug prices. My guess is he is right, and that something will be the “donut hole” in Medicare Part D. I also agree with Prof. Mankiw, that this will likely mean less research into new drugs in the future. And as Prof. Mankiw points out, “this is good news if you are going to get sick now, not so good if you are going to get sick in the distant future.” Frankly, I’d find it quite ironic (and sad) if the Democrats do close the “donut hole” and then it delays or even prohibits cures for things like Alzheimers and Parkinsons.

FILED UNDER: Campaign 2006, Economics and Business, Health, US Politics, , , , ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Original Article syndicated via RSS from Outside The Beltway | OTB

  2. Tano says:

    Ah yes, lets shield the drug companies from any effect of price negotiation from their biggest customers on the assumption that the excess profits they make are the only route to further R&D. Good free market thinking! In fact, why dont we, as a society, simply voluntarily pay twice the cost of what Pharma charges, so that we can have those cures twice as fast.

  3. Kent G. Budge says:

    Tano,

    Self-parody works better when it isn’t so heavy-handed.

  4. Patrick McGuire says:

    Defense related stocks took a hit too. I wonder if the “street” knows the future.

  5. Anderson says:

    Tano is, of course, correct. R&D is the path to future profits, given that the shell game of “wait, Zoloft *also* treats headaches!” can’t last forever.

    I would love to see a trustworthy study on how much of the gargantuan profits to date have actually been put back into genuine R&D (and not new off-label uses, say), and how many have been paid out to shareholders.

  6. RJN says:

    Tano and Anderson at the same time. I am glad I lived so long. Why don’t you fellows instruct whoever invests your pension funds to invest in the gargantuan profits of big Pharma?

  7. Steve Verdon says:

    Anderson,

    Well there is this CBO study and they mention this article, which looks intereting.

    Burton Weisbrod, “The Health Care Quadrilemma: An Essay on Technological Change, Insurance, Quality of Care, and Cost Containment,” Journal of Economic Literature, vol. 29, no. 2 (June 1991), pp. 523-552.

    What is interesting is the idea that there might be an over-investment in R&D due to things like how insurance in the U.S. is an un-taxed employee benefit along with the strong monopoly rights attached to new drugs.

    Tano,

    Ah yes, lets shield the drug companies from any effect of price negotiation from their biggest customers on the assumption that the excess profits they make are the only route to further R&D.

    Well exactly what other economic system has done better in providing lots of new drug treatments? I hear the Canadians and Europeans to a large extent use drugs developed here.

  8. Steve Verdon says:

    Anderson,

    Here is another paper you might interesting by Sherer.

    Thus, a robust pattern persists. Combined with evidence that profit rates of return on pharmaceutical industry R&D investments tend to exceed risk-adjusted capital costs by only modest amounts, the pattern suggests that pharmaceutical industry R&D is best described by a virtuous rent-seeking model.8 That is, as profit opportunities expand, firms compete to exploit them by increasing R&D investments, and perhaps also promotional costs, until the increases in costs dissipate most, if not all, supranormal profit returns. If this is a correct interpretation of the industry’s behavior, it has self-evident implications for policy interventions aimed at reducing industry prices and profits.

  9. Dave Schuler says:

    I have no problem with pointing out the benefits of subsidies as long as we acknowledge that they are subsidies. All sorts of things e.g. PC’s and the Internet in all likelihood would not have been developed without government subsidies.

    However, I don’t think it’s completely obvious that pharmaceutical X would not have been developed in the absence of subsidy Y. Surely that’s an empirical question, isn’t it? By that I mean it should be demonstrable with numbers rather than recourse to first principles.

  10. Dave Schuler says:

    I might add that the R&D budgets of pharmaceutical companies do not vary with revenues or profits (they vary with inflation) but that rent-seeking expenses do.

  11. Steve Verdon says:

    Here is one that uses a micro-simulation. Here is the abstract,

    Previous empirical studies that have examined the links between pharmaceutical price controls, profits, cash flows, and investment in research and development (R&D) have been largely based on retrospective statistical analyses of firm- and/or industry-level data. These studies, which have contributed numerous insights and findings to the literature, relied upon ad hoc reduced-form model specifications. In the current paper we take a very different approach: a prospective micro-simulation approach. Using Monte Carlo techniques we model how future price controls in the U.S. will impact early-stage product development decisions in the pharmaceutical industry. This is done within the context of a net present value (NPV) framework that appropriately reflects the uncertainty associated with R&D project technical success, development costs, and future revenues. Using partial-information estimators calibrated with the most contemporary clinical and economic data available, we demonstrate how pharmaceutical price controls will significantly diminish the incentives to undertake early-stage R&D investment. For example, we estimate that cutting prices by 40 to 50 percent in the U.S. will lead to between 30 to 60 percent fewer R&D projects being undertaken (in early-stage development). Given the recent legislative efforts to control prescription drug prices in the U.S., and the likelihood that price controls will prevail as a result, it is important to better understand the firm response to such a regulatory change.

    Granted that is just the abstract and there might be some ridiculous simplifying assumptions in the paper, but I’ll probably order it from the NBER tomorrow.

  12. Steve Verdon says:

    Dave,

    Regarding this,

    I have no problem with pointing out the benefits of subsidies as long as we acknowledge that they are subsidies. All sorts of things e.g. PC’s and the Internet in all likelihood would not have been developed without government subsidies.

    However, I don’t think it’s completely obvious that pharmaceutical X would not have been developed in the absence of subsidy Y. Surely that’s an empirical question, isn’t it? By that I mean it should be demonstrable with numbers rather than recourse to first principles.

    You appear to be contradicting yourself. On one hand you say that without subsidies we’d not get prodcut X. Then on the other you say, even without subsidies we could still get product X. Do you have a third hand that can clear up the issue? 🙂

  13. Dave Schuler says:

    I don’t see it as a contradiction, Steve. What I’m saying is that I think it’s perfectly reasonable to discuss two different but related points:

    1. Whether the subsidies that are being given are having the effects that are claimed.

    2. Whether we would prefer to subsidize one thing (say, research into a cure for Parkinson’s Disease) or another (say, funding Head Start fully).

    Effectiveness and relative merit are different subjects.

  14. Dave Schuler says:

    Interesting paper, Steve! Sounds directly on target. I look forward to what you find in it.

    My own analysis has simply looked at the PharmaCo annual reports, their PACs’ statements, and similar materials.

  15. Steve Verdon says:

    Dave,

    Oaky, I agree those are relevant topics. I guess I just didn’t see that as what you getting at the post in question.

    I’m not sure what subsidies you are talking about though…the Medicare drug program? Yes that is a subsidy, but not a new one, and is it really a subsidy for Big Pharma or seniors or both? My guess is more for the seniors in that they’d be buying many of these drugs anyways. If that is the case, then driving down those profits would have a negative impact on R&D if the linked papers are indeed correct in their conclusions.

  16. RJN says:

    Steve: From my own experience the Medicare Part D plan is a subsidy for both. If I did not get some help from Part D my wife and I would be spending $440/month in Canada instead of $780/month in the USA.

    The difference could be considered a subsidy to our domestic Pharma industry from retail on back.

  17. Steve Verdon says:

    RJN,

    Well in that case then all of Medicare is really a subsidy for the health care industry. And WIC is a subsidy for the dairy industry, and so on.

    I can see how Big Pharma would want to get in on the lobbying, but my view is that the subsidy is largely one for seniors and the aim of the subsidy is for drug consumption not actually R&D for new drug therapies…at least directly.

  18. RJN says:

    Steve: My point was pretty clear, I thought. Money spent in the United States for drugs goes, after retail and wholesale expenses, directly to the firm that did the original R&D for the drugs. Also, one is less likely to buy generics if he is getting help with his costs.

  19. spencer says:

    If the drop in these stock prices reflect fears about cuts in future research I wonder what the drop in the S&P index of pharmaceutical stocks of some 33% since George Bush took office implies for the future of drug research.