Gregory Reid
A century ago, the average American could expect to live into his or her mid-50s, maybe long enough to bounce a grandchild on a knee for a few years—so long as that knee wasn’t wracked with arthritis pain.
Today, that same person can expect to reach the late 70s, and perhaps climb a set of auditorium stairs using a rebuilt knee to see that grandchild graduate from college. Older people take medications that lower blood pressure or cholesterol, stave off the onset of heart disease, or keep diabetes in check. They might receive dialysis, which filters out waste for kidneys that no longer can do the job themselves.
Countless people have benefited from medical innovations that not only prolong life but improve its quality. These innovations have significant value for patients and society, but they can be time-consuming and expensive to develop, which has prompted some economists to investigate how to speed up and streamline the process of research, development, and regulatory approval.
In a 2006 study, Chicago Booth’s Kevin M. Murphy and Robert H. Topel estimated that US life-expectancy gains from 1970 through 2000 added about $3.2 trillion per year to US national wealth. Gains over the 20th century were worth about $1.2 million per person—the value Americans put on the years and quality of life added over that time.
“A lot of people think that the value of having people live longer is that they work longer and add to the GDP,” Topel says. “But that’s not it at all. There is value to individuals for living a bit longer and a little bit healthier. As just one example of improved quality of life, advances in orthopedic surgery allow millions of people to walk around who might otherwise be suffering from disabling injuries.”
Even modest gains in life expectancy can be significant. Nearly 40 percent of Americans can expect to get some form of cancer over their lifetimes. In the 2006 study, Murphy and Topel calculated that even a 1 percent reduction in mortality from cancer would be worth $500 billion in the United States alone.
There is a significant societal benefit to ensuring that new treatments, devices, and procedures make it to the patients who need them. But many of these innovations come from private companies beholden to investors and profit margins. Improving some treatments simply may not be profitable.
Consider the development of a new pharmaceutical. From identifying a potentially important molecule or compound to making it through regulatory approval and getting their drug to market, companies can face more than a decadelong process. One estimate from an industry-funded center suggests that drugmakers can expect to spend about $2.7 billion to get a new product into pharmacies.
At every step, someone has to decide how much the company might still need to spend—and if that cost will be worth it. If it looks as though the company might not be able to earn a profit on a drug, the company may cut its losses, even if the technology stands a good chance of later obtaining approval and extending or improving patient lives.
Chicago Booth’s Eric Budish and MIT’s Benjamin N. Roin and Heidi Williams say that corporate short-term thinking and the structure of the patent system may promote short-term research-and-development projects. They find that pharmaceutical companies disproportionately invest in developing drugs that treat late-stage cancers, and they argue that this is at least in part because these drugs can be brought to market relatively quickly. They also find that companies underinvest in drugs that could prevent cancer or treat it in its early stages, and that take a comparatively long time to commercialize. Yet patients would benefit more, in terms of added years of life, from the early-stage treatments.
The researchers argue that short-termism and problems with patent law “may generate incentives that distort private research investments away from inventions that have both a long useful life and a long commercialization lag.” (For more on how short-termism can distort research investment, see “How to curb short-termism and boost the US economy,” Summer 2019.)
Addressing these problems would have clear value for patients. The researchers find that US cancer patients diagnosed in 2003 lost a total of 890,000 life years because of “missing R&D” that companies would have performed if not for this distortion in incentives.
One potential improvement they suggest would be for the US Food and Drug Administration to approve more drugs using “surrogate endpoints,” which are valid proxies for mortality that speed up clinical trials. For example, cholesterol and blood pressure are surrogates for heart disease. In a trial, if a drug were shown to lower blood pressure, that could be used as evidence it would also reduce death from heart disease. Surrogate endpoints are already used in clinical trials for some types of cancer, and the researchers find more R&D associated with those cancers, especially for early-stage disease.
These surrogate endpoints couldn’t be used in every situation. They can be controversial, since changes in surrogate endpoints may not always correlate with improvements in patient survival. But in some cases, companies that can use surrogate endpoints to gain swifter regulatory approval might be more willing to invest in drugs that would otherwise take too long to bring to market.
“Let’s say, as a pure hypothetical, that a company had an idea for a vaccine that could prevent prostate cancer in otherwise healthy, 20-something males,” Budish says. “It would take a long time to prove that it works statistically. By that time, a lot of your patent protection would have lapsed. The vaccine might never get to the market because of that. Surrogate endpoints, if they could be identified, would help in a case like that.”
Tweaks to patent laws also could help. Companies file patents at the point of discovery to protect their inventions. That’s when the clock starts ticking, giving the patent holder 20 years before a competitor is allowed to market a generic version of a drug. The company producing the generic doesn’t have to invest nearly as much in R&D or in the regulatory process, so its pricing can be much lower, siphoning business away from the company that originally discovered or patented the product.
As a result, when companies choose which inventions to pursue, they look for those that can be commercialized as quickly as possible, lengthening the time they have to recoup their investments. “The patent system provides, perhaps inadvertently, very little incentive for private firms to engage in long-term research,” Budish, Roin, and Williams write.
But if patent law instead offered protection from the date the drug received approval or went onto the market, companies might be more inclined to invest in treatments that would take longer to be ready for sale, the researchers suggest.
Another option, says Chicago Booth’s Andrew McClellan, could be for regulators to use a sliding scale to grant approvals. For example, the FDA might consider easing the requirements during clinical trials if a drug poses little risk to patients but has potential to treat a widespread disease such as Alzheimer’s, which is a serious public-health issue.
“The regulator might say, ‘Because there’s a need for this and we want you to keep developing this, we’ll give you a slightly lower standard and require less evidence to get you to approval,’” McClellan says. “Exactly how much you want to change a standard depends on what the need is and what the benefit of the drug is versus the side effects of putting something poor on the market.”
Creating a sliding scale could equalize the incentives for the companies developing new technologies, which want approval as quickly and as cheaply as possible, and the regulators, who prioritize product safety over time and money.
The US federal government offers incentives to companies that develop “orphan drugs,” those that treat rare diseases or conditions. Without these incentives, companies might not be able to profit from developing a drug that treats a small pool of patients.
But even when the pool is large, some patients simply can’t afford a therapy. More than 27 million Americans still lack health insurance. And many who do have insurance face high copays or deductibles that can be financially crippling. About 26 percent of Americans have reported that they or someone in their household has had trouble paying health-care bills in the past 12 months. These limitations lead to patients leaving prescriptions unfilled and declining medical procedures.
When companies develop innovative treatments, such as immunotherapies that use the body’s own immune system to fight cancers, many potential patients can’t afford them. Consider Kymriah, approved in 2017, which uses the body’s T cells to fight B-cell acute lymphoblastic leukemia. Treatments can cost nearly $500,000, and a patient’s copay might be tens of thousands of dollars—an expense that would be out of reach for many.
But Chicago Booth’s Ralph S. J. Koijen and Columbia’s Stijn G. Van Nieuwerburgh argue that there is another potential payer with an interest in keeping those patients alive, and which also could afford the high costs: life-insurance companies.
Life-insurance companies make money the longer a policyholder lives. If cancer immunotherapy treatments will extend a policyholder’s life, the insurance companies stand to gain.
“Life-insurance companies are sharing in that benefit if you get that treatment,” Koijen says. “They don’t have to pay out if you stay alive. And the longer you stay alive, the longer you pay into the policy.”
Koijen and Van Nieuwerburgh find that the cancer immunotherapies on the market today are applicable to about 330,000 cases per year. If life insurance were to cover the copays for all those cases, the total cost would be about $4.1 billion per year. Life-insurance companies would stand to recover an estimated $7.7 billion annually as a result of being able to delay paying the death benefits for patients whose treatment was successful, as well as collecting additional premium payments from those patients. The treatment expenses could be financed by life insurers covering patient copays, insurers allowing patients to borrow against their death benefits for their copays, or other funding mechanisms, the researchers suggest.
Getting life-insurance companies in the payment mix would be good for patients and, when treatment adds years of life, good for the insurers too. But in other cases, where the gains to life expectancy from a given treatment are shorter, it’s reasonable to expect most of the costs of treatment will continue to be borne by health-insurance companies—an arrangement that Booth’s Topel suggests can skew decision-making about which treatments are worth the expense. Patients’ expectations that any and all treatments will be covered by health insurance creates significant inefficiencies that alter the types of innovations that come to market, he says.
For example, about a decade ago, eight new lung-cancer drugs came on the market, all of them targeting patients in the late stages of the disease. One drug, Avastin, increased patient lives by an average of only a few months and cost tens of thousands of dollars.
Topel argues the drugs that can gain cost-effective approvals aren’t necessarily the ones society most needs. Still, they will generally be covered by health insurers. “If I were paying directly for my own care, I’d look at the price and ask if it’s worth it,” he says. “We do that for other products that we consume, but we don’t do it for medical care because we consume those benefits mainly through insurance. If you invent a procedure for making victims of cancer live a little bit longer, it’s very difficult to deny that care downstream once that innovation is in our inventory. The way we allocate resources—build it and they will come—distorts incentives.”
In other words, Topel says, if health insurers could prioritize paying for treatments that provide the most-cost-effective improvements in life expectancy and quality of life—a big “if” in a world of third-party payers for medical care—innovators would in turn prioritize developing treatments that provide these outcomes.
A lack of competition in some corners of the health-care industry also decreases companies’ incentive to innovate. London Business School’s Colleen Cunningham and Yale’s Florian Ederer and Song Ma find evidence of this among drugmakers that initiate “killer acquisitions” to eliminate competition from rivals.
Pharmaceutical companies have an incentive to purchase a rival that is developing competing drugs and then abandon the former rival’s projects. Analyzing more than 16,000 drug projects originated by more than 4,000 companies, Cunningham, Ederer, and Ma demonstrate that a project acquired by a company that sells an overlapping drug is nearly 30 percent less likely to be continued in the development process than a project initiated by the acquiring company. “An incumbent firm may acquire an innovative entrepreneur simply to shut down the entrepreneur’s projects,” the researchers write.
These deals often evade review by the Federal Trade Commission since they aren’t large enough to trigger mandatory premerger notification requirements. The researchers observe that company acquisitions of rivals with competing drug projects often fall just below the transaction value required to notify regulators. Acquisitions of rivals without competing drugs do not display a similar pattern.
In fact, the problem of “stealth” deals in the health-care sector extends far beyond the pharmaceutical industry, according to Chicago Booth’s Thomas Wollmann. He used economy-wide merger and enforcement data to study a 2000 amendment to US law that abruptly increased the thresholds below which businesses are exempt from premerger reporting requirements.
Examining US premerger notifications from 1994 to 2011, Wollmann finds that after the amendment took effect, the number of premerger notifications received by the FTC and the US Department of Justice fell by nearly three-quarters. He also finds that among newly exempt deals, antitrust enforcement fell sharply while mergers between rival companies increased.
“These findings indicate that many companies, knowing that they are less likely to face antitrust scrutiny after the amendment, become more likely to propose deals with competitors,” says Wollmann.
His data also indicate that health-care-sector deals play a disproportionately large role in this phenomenon.
“Hospital systems, providers of ambulatory and home health-care services, medical device manufacturers, and dialysis facilities are all overrepresented,” he says. “These industries alone combined for thousands of mergers over the past two decades.”
Such evasions of notification thresholds underscore the importance of policy design in encouraging medical innovation: companies will seek to maximize their profits within the bounds set by regulators and policy makers, so it’s up to those individuals to craft a regulatory system that offers the incentive to innovate. Changes to the patent system, the treatment-approval process, and antitrust regulation—together with private-sector developments such as mutually beneficial subsidies for expensive treatments—could help medical science continue its progress toward longer, healthier human lives.
Two of the world’s most dynamic economies face contractions, judging by a half century of data linking rising household debt with a boom-bust pattern.
China and South Korea Had the Boom. Is a Bust Imminent?
A study of demolitions in Chicago finds they raised housing costs, hurting renters.
Infographic: How Demolishing Public Housing Increased Inequality
The two ideologies appear to contradict each other, but their histories are intertwined.
Communism and the Chicago School: The Forgotten ConnectionsYour Privacy
We want to demonstrate our commitment to your privacy. Please review Chicago Booth's privacy notice, which provides information explaining how and why we collect particular information when you visit our website.