Pharmaceutical R&D and the Evolving Market for Prescription Drugs

October 27, 2009

Investment in research and development (R&D) over the past several decades has produced a wealth of valuable new drug therapies. Current and future pharmaceutical R&D will determine what drug therapies will become available, and thus will influence future health-care costs.Yesterday CBO released a brief that describes the state of investment in drug R&D and the factors that influence it. It also examines how various policy options to control the growth in health care costs or to expand insurance coverage could affect spending on R&D.

Rate of New-Drug Development

Spending on prescription drugs rose rapidly between 1994 and 2004, but has grown more slowly since then. The rising-then-slowing pattern of growth in prescription drug spending, as shown in the figure below, is related to the evolving pace of new-drug introductions and patent expirations over the past two decades. Specifically, drug introductions spiked in the mid- to late 1990s but have declined since 2000in most years, back to levels not seen since the 1980s. The introduction of priority drugs (those that, according to the Food and Drug Administration, provide a significant therapeutic or public health advance) has also subsided.

Slower revenue growth for drugmakers does not mean that consumers are using fewer prescription drugs. In fact, the total number of prescriptions continues to increase, albeit more slowly since 2004. But generic drugs, which cost less than their brand-name counterparts, comprise a greater share of prescriptions, having risen from 42 percent in 2000 to 58 percent in 2007.

Investment in R&D

According to Pharmaceutical Research and Manufacturers of America (PhRMA), the industrys trade association, member firms spent $50 billion on pharmaceutical R&D in 2008, a 2.6 percent real increase over the previous year. That increase is unusually small; over the past 30 years, PhRMA has seldom reported less than a 5 percent real annual increase in R&D spending, and the average has been almost 9 percent. Generally, pharmaceutical R&D in the private sector is complemented by health-related research funded by the public sector, mostly through the National Institutes of Health. Analysts have found that increased public spending on basic (health-related) research stimulates additional private drug R&D.

Real R&D spending per successful new drug has been rising for many years, largely because of growth in the size and length of clinical trials and an increased rate of failure. Those changes generally reflect drug companies strategic choices about which kinds of drugs to pursuechoices that depend on anticipated demand and scientific opportunities. In particular, drug companies are devoting more resources to developing drugs for chronic illnesses, which generally require longer clinical trials.

The Role of Health Insurance in the Demand for Prescription Drugs and Drug R&D

Insurance plays asignificant role in determining the demand for prescription drugs and, ultimately, drug R&D. By shielding individuals from the full costs of the drugs they use, insurance encourages higher spending on drugs. Further, the scope of health insurance coverage of prescription drugs has been expanding for many years, as has the number of prescriptions being filled. From 1997 to 2007, the share of consumers total drug expenses paid for by third parties (private health insurance plans and public programs) rose from 67 percent to 79 percent. At least partly as a consequence, the number of prescriptions increased by 72 percent over that same period.

Prospective Policy Options and Their Implications for R&D

The federal government finances a large and growing share of prescription drug sales, and it faces severe long-term budgetary pressures, with rising health care costs playing a key role. CBOs brief discusses a number of policy options for reducing those costs or for expanding insurance coverage that would affect the market for prescription drugs. Those optionssome of them detailed in the Congressional Budget Offices December 2008 report, Budget Options, Volume 1: Health Careinclude:

  • Expand prescription drug coverage
  • Expand the Medicaid rebate paid by manufacturers of brand-name drugs
  • Require drugmakers to pay a minimum rebate on drugs covered by Medicare Part D
  • Increase the availability and use of follow-on biologic drug products
  • Incorporate findings on comparative effectiveness into decisions about insurance coverage

This brief was prepared by David Austin of CBOs Microeconomic Studies Division and Colin Baker of CBOs Health and Human Resources Division.