March 15, 2005 (Vol. 25, No. 6)
Critiques Ignore Basic Economics
The pharmaceutical industry used to enjoy the luxury of going about its business in relative obscurity. To be sure, the industry faced critical issues, like the level of oversight the FDA should exercise over new drug applications—but these matters fell into the wonky province of academics and policy makers.
In the last decade, however, criticism of the drug industry, fueled by the rising cost of health care, has become strident. Proposals have surfaced to control drug prices, import lower-cost drugs from Canada, regulate drug marketing, and subsidize the prescriptions of Medicare patients. The outcome of these debates has the power to make or break the companies at issue.
Jerome P. Kassirer and Marcia Angell, both former editors in chief of The New England Journal of Medicine, are two of the industry’s harshest critics. The titles of their respective new books, On the Take: How Medicine’s Complicity with Big Business Can Endanger Your Health and The Truth About the Drug Companies: How They Deceive Us and What to Do About It, reveal Kassirer’s and Angell’s shared conviction that the current practices of pharmaceutical firms border on intentional misfeasance.
But the authors are wrong. Their inability to grasp fundamental economic principles about market incentives, gains from trade, the time-value of money, and the importance of innovation leave the authors open to easy attack. Reading these books, I felt proud to be an occasional consultant for PhRMA, the industry trade association, and Pfizer, the largest pharmaceutical firm.
Kassirer argues that drug marketing corrupts both the companies that do the pushing and the doctors who yield to their blandishments. A doctor with undivided loyalty to his patients cannot resist temptation when a zealous sales force pushes overpriced and often dangerous products onto the market.
Angell echoes these concerns and offers a more extended indictment. Pharmaceutical firms have been the beneficiaries of government largesse, she says. In her view, they grievously overstate the costs of bringing new drugs to market in hopes of wringing extortionate payments from desperate patients. They adopt foolish strategies for research and development, producing me-too or copycat products with little medical benefit, she contends, while falsely taking credit for scientific innovations underwritten by the National Science Foundation and the Institute of Medicine.
The pharmaceutical companies benefit from a patent system that they can game, and from a lax FDA process for drug approval, Angell insists, and they use devilish advertising campaigns to promote their wares.
In response to these perceived failings, Angell favors a stiff dose of price controls, tougher FDA approval procedures, restrictions on advertisements, and sharp limitations on drug patent protections. She would undo both the Hatch-Waxman Act of 1984, which extends the patent life of all drugs in order to partially offset the lost sales from those that have been patented but await FDA approval, and the reforms that allow drug companies to help finance the costs of the FDAs new drug applications.
Drugs are a complex business, and each of Angell’s proposed reforms would produce a myriad of unintended and often destructive side effects. Remove industry payments to expedite FDA review, for example, and desired new drugs will take longer to reach the market. That in turn will truncate the life of patents and reduce innovation. Experts in the field ponder the trade-offs. Angell and Kassirer write as if the trade-offs do not exist.
Kassirer’s favorite targets are the salespeople who promote new drugs by wining and dining physicians at fancy restaurants or in exotic locations. Assume these firms are out to make a profit, like a firm that sells computers or honeymoon vacations. Why are their practices detrimental to social welfare? Kassirer never asks this key question.
One answer is that the drug companies marketing strategies create a conflict of interest between physician and patient. But conflicts are so universal in medicine that they can never be banished. Any surgeon who recommends surgery to a patient creates a conflict for himself, since she or he would be the doctor performing the operation. We rely on second opinions to minimize such conflicts, and because such opinions are too costly to be mandated, we back them up with a combination of professional ethics, peer review, and disclosure.
New drugs are often funded by government grants that allow scientists to convert their academic research into commercial products. It is unthinkable to ban these relationships, though it is imperative to regulate them.
Do doctors who are wined and dined by ad reps face a conflict that is more pernicious than those in other areas of medicine? I doubt it. Note the counterforces at work. Aware of the temptations, many physicians sign pledges that they will recommend drugs based on the best available evidence, not promotional materials.
That promise isn’t idle, for it’s backed by loss of reputation for the physicians who break it. More critically, no single salesman controls the flow of information. A salesperson from Merck, for example, can always offer information to contradict the pitches of a sales rep from AstraZeneca.
Independent studies, once published, often favor the product of a third party. This raises the issue of conflict of interest. What Kassirer does not understand is that while its never possible to eliminate conflicts, it is possible to manage them.
Kassirer is also off-base when he attacks the drug companies’ sales efforts as a waste of precious resources. Suppose Congress ordered Pfizer to fire all 12,000 sales reps on its payroll. Would doctors and consumers find out about the company’s new drugs through neutral studies, that might take two years to come on line?
Such delays would serve no social interest. Advertising doesn’t simply dull the senses of easily duped consumers; it’s an important vehicle for information. Ads shouldn’t make fraudulent promises, but the law already protects against such rare abuses.
Pharmaceutical sales costs are high (though no higher than the sales costs of many other industries), for a reason that Kassirer nowhere addresses: in industries with high fixed costs and low marginal costs, we want firms to invest in sales that will have the effect of lowering the average price of products. The first pill may cost hundreds of millions; the second perhaps costs a dollar.
The high fixed cost on the front end has to be spread over the product’s entire run, which means that consumers are better off when advertisements generate additional sales.
Given the costs and benefits, Pfizer will work to pick the correct number of salespeople, as will its competitors. The vagaries of market demand mean that companies may make mistakes in this area. But why trust Kassirer or anyone else to choose a better number?
Rezulin as an Example
As an example of a drug that should never have made it to market in the first place, Kassirer offers Rezulin, the diabetes drug marketed by Warner-Lambert. In 1999 Rezulin was withdrawn from the market after extended hearings and negotiations with the FDA. Relying on the Pulitzer Prize-winning reports of David Willman of the Los Angeles Times, Kassirer treats this episode as an example of dangerous FDA dilly-dallying.
I have helped defend Pfizer in the various lawsuits that grew out of the Rezulin recall, and there is another side to the story. Rezulin offered a new mechanism for managing insulin, and it was, without question, highly effective for many of its 1.5 million users.
But it also was associated with a rise in liver damage. Despite warnings about these side effects, 63 people, all of them already ill, died from liver complications due in whole or in part to Rezulin.
Still, it’s doubtful that Warner-Lambert (later Pfizer) should have been pressured to take Rezulin off the market. The benefits to the patients who took the drug count as much as the costs. You can’t buy this drug back from these patients, Dr. Steven V. Edelman, a professor of medicine at the University of California, San Diego, told the FDA in March 1999.
The number of people helped by Rezulin dwarfs the number hurt. But after the drug was withdrawn, 9,000 lawsuits were filed, many of them as class actions, seeking recovery for millions of individual users and their insurers.
How did 63 deaths generate so many filings? The suits often demanded a refund of the full price of Rezulin that had been successfully used, without any side effects, on the grounds that the patient wouldnt have used the drug if he or she had fully appreciated its risks. Go figure.
At the time Rezulin was withdrawn, there were two drugs in the same family (Actos and Avandia) on the market. But they arguably did not help some patients as much as Rezulin had, even if they had fewer serious side effects.
Those who could tolerate Rezulin were better off with it on the market. Those who could not were well advised to shift to a different drug: me-too drugs benefit health and safety because of these differences in patients risk profiles.
Currently, it may be acceptable to pull Vioxx off the market because patients who suffer arthritis and chronic pain can switch to Celebrex or Bextra. Without me-too drugs, we put all our eggs in one basket, which is always a dangerous strategy.
Drugs Are Different
Angell’s basic argument is that drugs are different—so different that their development can’t be left to a vastly underregulated for-profit industry. She is long on denunciations but utterly confused on key policy issues.
Angell’s chief target is an oft-cited economic study that estimated the cost of bringing a new chemical entity to market at $800 million. She attacks the drug industry for using this study to inflate its own cost estimates in order to justify its high prices for new drugs. Disputes over cost figures are always fair game—but not on Angell’s grounds.
Her key complaint is that the companies should not include in their cost estimates the time-value of money that reflects the delays in bringing a new drug to market. But everyone knows that time is money. You would rather pay $500 in five years for a new TV you get to use starting today, because youd have the use of the money in the interim. High finance turns that instinct into a first principle: Even with zero inflation, a dollar today is not worth a dollar tomorrow, especially if tomorrow is 10 or more years away.
On this score, drug development is not different from any other investment. If drug companies have to wait 10 years to get a return on their investment, investors or lenders will have to pony up the dough, which means that they’ll expect some return for their contribution.
So why shouldn’t the pharmaceutical industry factor the interest it must pay into its cost estimates? It is fair to ask how much interest a drug company has to pay to borrow capital (though given the risky nature of their investments, lenders to the pharmaceutical industry will rightly ask for a high interest rate). But it is fantasy to assume that it need not worry about the cost of borrowing money at all.
Even using the drug companies’ inflated cost estimates, Angell smugly claims, the total profits of the industry exceed its research and development budget. As a result, she thinks that it would be painless for the industry to reduce its revenues by accepting price controls and restrictions on its promotional activities. This striking claim ignores an iron rule of economics: Price controls create shortages and stifle innovation. How much dislocation they create is always open to dispute. But Angell fails to explain how the regulation she proposes won’t backfire.
Angell’s price controls have one virtue: they divert her from supporting drug importation at prices dictated by foreign governments or suppliers. But it’s wishful thinking to imagine that price controls don’t influence everything a firm does. Companies need to make a decent return on all their activities in order to stay in business.
If a pharmaceutical house made 18% profit on a research budget that was one sixth of its total costs, and nothing more, its total rate of return would sink to 3%, and it would have to close up shop.
Like Kassirer, Angell attacks the FDA for approving me-too drugs like Vioxx, Celebrex, and Bextra, or the six anticholesterol drugs Mevacor, Lipitor, Zocor, Pravachol, Lescol, and Crestor. In her view, research has no value when it replows ground previously covered by others, offering drugs that are chemically distinct but functionally equivalent.
Instead of recognizing that redundancy is an important form of social protection, Angell wants the FDA to revise its rules by testing each new drug against the patented drug in the same family, and to license for sale only the newcomers that represent clear improvements over the status quo.
What a disaster! The law has always set its face against patents that are broader than necessary and that stifle competitors. Samuel Morse was allowed to patent his telegraph back in 1840, but not any other device that allowed for electromagnetic transmission over wires. Now in a misguided burst of medical professionalism, Angell wants to introduce bigfoot patents through the FDA’s backdoor.
If her policy were in effect, then Merck’s recent decision to withdraw Vioxx would be far worse for consumers because there would be no Celebrex or Bextra. We don’t keep a new detergent or radio off the market because there are good ones already available for sale. Angells facile claim that drugs are different in this regard doesn’t warrant the costs that her proposal would impose.
Angell and Kassirer, then, have written books so one-sided and shrill that heeding their call to action would cause the entire pharmaceutical industry to collapse. Their brave new world would reduce the industry’s size and effectiveness, increase costs to consumers, slow the pace of innovation, lead to job cuts, and generously increase the level of human misery.