Generic Competition and the Incentives for Early-Stage Pharmaceutical Innovation

Abstract

Over the last decade, generic penetration in the U.S. pharmaceutical market has increased substantially, providing significant gains in consumer surplus. What impact has this rise in generic penetration had on the rate and direction of early stage pharmaceutical innovation? We explore this question using novel data sources and an empirical framework that models the flow of early-stage pharmaceutical innovations as a function of generic penetration, scientific opportunity, firm innovative capability, and additional controls. While the aggregate level of early-stage drug development activity has increased, our estimates suggest a sizable, robust, negative relationship between generic penetration and earlystage pharmaceutical research activity within therapeutic markets. A 10% increase in generic penetration is associated with a 7.9% decline in all early-stage innovations in the same therapeutic market. When we restrict our sample to first-in-class pharmaceutical innovations, we find that a 10% increase in generic penetration is associated with a 4.6% decline in early-stage innovations in the same market. Our estimated effects appear to vary across therapeutic classes in sensible ways, reflecting the differing degrees of substitution between generics and branded drugs in treating different diseases. Finally, we are able to document that with increasing generic penetration, firms in our sample are shifting their R&D activity to more biologic-based (large-molecule) products rather than chemical-based (smallmolecule) products. We conclude by discussing the potential implications of our results for long-run welfare, policy, and innovation. IntroductionIn his provocative paper, "The Health of Nations," Yale University economist William Nordhaus (1999) argues that the advances in human welfare generated by better medical science over the past half century have been equal in value to the consumption increases from all other sources put together. Victor Fuchs (1982) has suggested that most of the real improvement in human health generated over this period stems from modern medicine's expanding arsenal of pharmaceutical products. While documenting these claims in a way that meets modern evidentiary standards is challenging, the work of scholars such as Frank Lichtenberg (2001, 2004, 2007) has provided evidence suggesting that the gains from pharmaceutical innovation have been very large. In the long run, global investments in pharmaceutical research have proven to be very good ones.These benefits have come with significant costs; pharmaceutical innovation is risky and expensive. These costs are passed on to consumers in the form of higher prices for branded pharmaceuticals. In recent years, prescription drug spending in the U.S. has exceeded $300 billion, an increase of $135 billion since 2001. Consumption of prescription drugs now accounts for approximately 12 percent of total health care spending (GAO, 2012). However, over this time period, generic products have accounted for an increasing share of prescription...

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