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Jewish World Review July 7, 2000 /4 Tamuz, 5760

Amity Shlaes

Amity Shlaes
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Consumer Reports

How to destroy the pharmaceutical industry

The US pharmaceutical sector is successful because heavy investment is sometimes rewarded with big profits -- US DRUG COMPANIES ought to be bursting with joy. The joint announcement by Craig Venter of Celera Genomics and Francis Collins of the National Human Genome Project of the mapping of the human genome opens the way to unprecedented innovation. Instead the industry is fussing about a bit of workaday federal legislation, and even claiming that it will stifle the creativity that the genome project represents.

At issue is a modest-sounding plan under which Washington would subsidise drug purchases for senior citizens. Through Medicare, the government already pays for the elderly's doctors and hospital stays. The White House and Congress merely want to expand Medicare to include some cash for drugs. And it is far from clear the plan will become law this year.

Still, the very idea of the programme troubles shareholders. Back in early March, when the prescription-drug entitlement first popped up on the political horizon, the stocks of Merck, Pfizer, Schering-Plough and Johnson & Johnson plummeted, roaring back only when the legislation's chances of immediate passage dimmed.

The companies' concern is a simple one. Drugs in the US have long been the one area of medicine free of public-sector control. Drugmakers have therefore also been free to spend nearly five times the average of other industries on research to chase a single goal: profit. The result has been spectacular innovation. While everyone recognises the role of Dr Collins' government-supported project in the genome advance, for example, few dispute that the work was completed as fast as it was because of investment, research and pressure from the hotdog Dr Venter.

Now the drugmakers fear that introducing the notion that drugs are a citizen's right will encourage demands for wider subsidy, and put the nation on the path to mass government purchases and price constraints. "This would inevitably lead to price controls, which would reduce research spending on the very sort of high risk projects that lead to breakthroughs," says Ken Abramowitz, healthcare analyst at Sanford Bernstein.

It is a mental leap, but one the drug industry, by nature a long-term thinker, is ready to make. And while direct evidence that price controls reduce innovation is hard to come by, there is plenty of evidence of a correlation between the two.

Patricia Danzon of the University of Pennsylvania's Wharton School compared innovation rates in countries with price controls to the rate in countries without them. She found that the countries that have price controls, such as France, Italy and Japan, have not been very innovative in drugs. A study by Etienne Barral of Rhône-Poulenc, found that three nations with relatively few price constraints - the US, Switzerland and Britain - produced 102 of the 152 new drugs that became global products between 1975 and 1994. A total of 45 per cent of the new products were from US companies.

Consider the example of France, which forces companies to agree to prices before they can sell new drugs. The Barral study found that country produced only 3 per cent of drugs between 1975-1994. Bigger companies such as Rhône-Poulenc could get around that by merging with groups in freer markets; today Rhône-Poulenc is part of Aventis, which markets and researches heavily in the US. But smaller companies did not have the same advantage. France has Genset, a genomics company, but it is no Celera.

Regulation forces another problem in Japan. There, generous government reimbursements are made for new drugs but an annual step-down system imposes increasingly strong price restraints on older drugs. The result has been a lot of churning in the market - putting new labels on not very new medicine.

Britain might seem to be an exception here. It does place some constraints on company profits. Yet its companies are heavily innovative: Viagra was developed in a British lab. The argument is that having the government as a reliable customer also serves drug companies, by cushioning them against business-cycle shocks. But the government does not set prices for new products in the French way. This difference seems to have helped British companies to keep up.

More importantly, the breadth of the freewheeling US marketplace has stoked profits in companies based in countries with price controls. They pull in extra revenues by licensing or selling drugs in the US. Indeed, the drive to be part of the US market is at the root of merger mania that has seized the industry in recent years.

Price-control nations, including neighbours Canada and Mexico, have, for their part, been free riders on the US train. Penning in the US cash cow might limit resources for non-US drug companies. Nor might the damage be confined to the developed world. Controls on profits could mean that a Pfizer would not be able to offer, as it has done, to supply Aids-plagued South Africa with an important anti-fungal medicine. To be sure, many in Washington are arguing that the drug industry is a bunch of doomsayers. Modest government purchases, they say, do not lead willy-nilly to price controls.

But this argument fails to acknowledge the high-stakes culture of pharmaceuticals. In an industry where only three in 10 drugs earn back their investment, deep pockets and freedom are crucial and decisions are made on the margin. To get genome-scale innovation rapidly, says Mr Abramowitz, "you have to have a company that is smart enough or crazy enough to want to try a wild project like deciphering the genome in the first place". Even a hint of intervention, he says, will cause them to moderate their bets, or redirect their legendary energy. In other words, the US should think hard before disturbing its Craig Venters.

JWR contributor Amity Shlaes is a columnist for Financial Times . Her latest book is The Greedy Hand: How Taxes Drive Americans Crazy and What to Do About It. Send your comments by clicking here.


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