Pharmaceutical Lemons: Innovation and Regulation in the Drug Industry

Abstract

Before a new drug can be marketed the Food and Drug Administration must be satisfied that it is safe and effective. According to conventional wisdom, the cost and delay involved in this process diminish the incentives to invest in the development of new drugs. Accordingly, several reforms aimed at restoring such incentives have been implemented and others have been advocated.This paper challenges the central argument in the debate on the topic, namely that drug regulation and drug innovation are necessarily at odds with each other. Although intuitively appealing, the argument that drug regulation negatively affects the incentives to innovate does not fully capture the role that regulation plays in this industry. This paper shows that the regulatory framework is not solely a burden imposed on the industry; it also provides a valuable service to the industry.Specifically, drug regulation provides certification of drug quality. Such certification, which may not be easily achieved by private market-based mechanisms, prevents the market from becoming a market for lemons. Therefore, rather than decreasing the expected returns to innovation, this aspect of regulation contributes to the value of new drugs and may actually encourage innovation. This point has largely been absent from most cost-benefit analyses of drug regulation, yet without it any discussion of the merits of regulation is incomplete.

“The Good, the Bad, and the Ugly Weed”: How Consumers in Four Different Policy Settings Define the Quality of Illicit Cannabis

“…In response to concerns about the safety of cannabis when legalized, information disclosure (labeling; Kilmer, 2014) and the introduction of quality standards on cannabis production (Pacula et al, 2014; Spithoff et al, 2015) seem warranted, as in the food or pharmaceutical industries (Grunert, 2005; Katz, 2007). This analysis shows that people who use cannabis across different jurisdictions are, in fact, concerned about its safety and the way it has been produced.…”

“…Sellers tend to have better information about quality features than buyers and can use this to generate excess profit (Kolodinsky, 2012; Vining & Weimer, 1988). This has been considered a market failure, referred to as “information asymmetry.” Consumer protection policies have been put in place to compensate for this asymmetry and to prevent buyers from purchasing “lemons” - an economic term originally describing faulty products on the used car market (Akerlof, 1997) and broadly applied to areas such as food safety or pharmaceutical regulations (Katz, 2007; Kolodinsky, 2012). According to some scholars, however, the rise of the Internet and the reputational feedback provided by consumers online can mitigate the “lemons” problem (Dellarocas, 2003; Malbon, 2013) and the related need for market regulation (Thierer et al, 2015).…”

Innovation in Chemistry, Manufacturing, and Controls—A Regulatory Perspective From Industry

“…However, Katz et al 186 and Eisenberg et al 187 argue that the increase in social regulations adds compliance value, and products are now less likely to be faulty. However, it is difficult to determine whether the added compliance value outweighs the cost associated with higher compliance burden.…”

Closing the Regulatory Gap for Synthetic Nicotine

“…181 The need for this consumer protection arises because most drugs are “credence goods,” meaning their safety, effectiveness, and quality cannot be readily and easily evaluated by patients and prescribers. 182 This results in an information asymmetry. Prescribers and patients cannot access full information about the risks and benefits of a drug, and thus cannot make decisions that will force harmful or ineffective drugs from the marketplace.…”