FDA Approval Process and Market Failure Mechanisms
Federal regulations provide policy makers with a broad spectrum of tools to execute national policies and laws. For example, some federal regulations, including those for biopharmaceutical products governed by the FDA, are intended to regulate consumer products to safeguard the health and safety of the general public. Other regulations attempt to control economic markets in order to remove obstacles that prevent those markets from achieving the right equilibrium price and quantity.
Unlike most other federal regulations that simply either prohibit or endorse certain actions, the FDA regulatory process to approve new biological drugs as safe and effective can be viewed as an actual service, with a unique economic supply and demand relationship. The American public demands this regulation as a public health service, and Congress primarily pays for this demand via appropriations that set the FDA’s annual budget. The FDA itself supplies this service at a quantity based on the federal appropriation amount and those allowable fees it can collect from industry under the Prescription Drug User Fee Act (PDUFA). Biopharmaceutical firms consume this service as they apply for FDA approval and execute the regulatory process. Under ideal economic conditions, the FDA’s services should spread benefits equitably amongst the consumers and suppliers while minimizing public costs and maximizing public benefits. Unfortunately, the current market for FDA services is hampered by at least two proposed market failure mechanisms that affect the larger commercial biopharmaceutical market.
First, the market for FDA regulation exhibits what economists refer to as a positive externality. A positive externality describes an economic condition in which the value of the good or service to society is greater than the value to the individual purchaser; therefore both the equilibrium price and the quantity produced are too low. The entire U.S. populace benefits by new biopharmaceutical products and services that the FDA certifies to be both safe and effective. Therefore, society stands to benefit from those increases in the supplied quantity of FDA regulatory services that result in reduced review times, higher throughput of new drug certifications, and improvements to the quality of the FDA’s regulatory services.
To illustrate this point, consider the biopharmaceutical industry’s consumption of the FDA’s services, proposed as the number of annual new biological licensing applications, over the last decade. In 2008, the FDA noted a 20% increase over the five-year average for new biological drug applications, highlighting a growing consumption of this service by the biopharmaceutical industry.5 Just three years later, however, the FDA noted that the number of new applications had dropped to the second lowest level in 10 years.6 Despite these short-term reductions in market-driven consumption, the biopharmaceutical industry continues to cite long lead times to gain FDA approval. This repeated criticism lends weight to the analysis that there is a supply bottleneck in, or otherwise underproduction of, FDA services that hampers the industry at large and leads to suboptimization of societal benefits gained from existing supply levels of FDA services.
Congress passed and has made several amendments to the PDUFA in response to growing evidence of a supply bottleneck at the FDA. PDUFA allows the FDA to charge and collect a fee from the industry applicant for each new biological licensing application. The Act does, however, place a ceiling on the total annual amount of fees collected and the level of each fee. In effect, the PDUFA reoriented market equilibrium price for FDA services, providing greater societal benefits through increased FDA services. PDUFA provides the FDA with a pricing subsidy mechanism that encourages it to supply additional regulatory services (~62% of annual budget for pharmaceutical regulation) at a higher price point then it could otherwise achieve based on Congressional Appropriations.7 Indeed, the FDA noted significant reductions in median approval times for applications after passage of PDUFA.8 However, it remains to be seen whether the current version of PDUFA provides adequate revenue ceilings to optimize the supply of FDA services to maximize societal benefits without jeopardizing the quality of service.
The second market failure that arises from the unique market for FDA regulation is the fact that the FDA enjoys a monopoly as the sole service provider. As a monopoly, the FDA has little competition to further drive down the price (in this case the quantity of resources provided given an appropriated budget) of its service. There is also no domestic peer competitor to benchmark the FDA’s performance or compare quality of service against. Despite pressure from Congress, the biopharmaceutical industry, and the general public on the FDA to achieve higher quality at reduced cost, the lack of a true peer competitor provides no other baseline for comparison and alleviates some of the pressure on the FDA to improve efficiency and reduce costs.
The combination of the two identified market failures signal that the market for the FDA’s services has not fixed at either an optimal price point or quantity supplied. This leads to lost market transactions for FDA services that should otherwise be occurring or lost social benefit derived from an increased supply of the FDA’s services. This analysis lends credence to the biopharmaceutical industry’s claim that every day lost to FDA review leads to potentially millions of dollars in lost profit.9