The term “Political Economy” is a former name of the discipline of economics. Today it is used in a number of senses, and its usage continues to evolve. Common to most of the modern interpretations is the economic analysis of tension in policy choices in a context that recognises both political and economic influences (Groenewegen 2008). In this book, the Political Economy of New Drugs (PEND) is defined following the precedent set by Comanor in his 1986 paper: “The Political Economy of the Pharmaceutical Industry”. While Comanor did not explicitly define his use of this term, it can be inferred that the political economy of the pharmaceutical industry concerns the economics of the critical choices governments need to make about the pharmaceutical industry and its regulation. He identifies economics as a “practical science” the practitioners of which have always been interested in the “critical choices” by governments.¹

Of particular interest to Comanor was the relationship between the economist’s research agenda and the politics of pharmaceutical regulation. He found that the political economy framed the research, and as the political debate changed so too did the research.

In this book the focus is “the political economy of new drugs”: the factors that influence how any surplus associated with a new drug or a future drug is allocated across stakeholders, including consumers, purchasers, budget holders and firms.² The relationship between the economic research agenda and the political process identified by Comanor is also a central issue in this book. This book’s focus on the political economy of new drugs rather than the pharmaceutical industry itself reflects the increased role of CEA in informing pricing and the capacity for industry, researchers and institutions to quantify the innovation associated with individual new drugs.

One way that the pharmaceutical industry seeks a share of a new drug’s surplus is through lobbying. Lobbying plays an important part in the allocation of surplus associated with patented innovation in any sector of the economy. In the case of new drugs, lobbying tends to focus on the question of an appropriate price for a new drug, given the health-generating potential of both that drug and of future innovation funded by sales of the drug. The associated policy choices include: (1) whether new drug price should be regulated; (2) the selection of a decision threshold price in a reimbursement process; and (3) whether bilateral Free Trade Agreements (FTAs) with the US should be used by the US to prevent partner countries from regulating the price US firms prefer for their new drugs.

In the broader economy, lobbying by patent-holding firms is characterised as rent seeking or rent protection.³ In the prevailing PEND, lobbying for higher new drug prices is instead characterised as providing incentives for investment into further R&D. This way of framing the impetus for lobbying links increased price to both increased profits and increased future health outcomes, thus creating an apparent win-win situation for firms and consumers. These claims of the relationship between new drug price and future health are supported by peer reviewed research and government studies (Comanor 1986; Scherer 2000; International Trade Administration 2004; Vernon et al. 2009). This evidence base supports the claim that the relationship between price and R&D investment is positive and that new drugs are a key driver of improved longevity (life expectancy) for consumers.⁴ The claim that firms rely on non-capital market-funded R&D rather than capital market borrowings due to the riskiness of this investment is supported by the pharma-economic literature.⁵ The claim of and evidence for a win-win outcome to the policy of higher prices for new drugs is critical to the success of lobbying by US Pharma.

Comanor argued that the political economy of the pharmaceutical industry shaped the economic research agenda, most notably the premise that there is a trade-off between savings today and health tomorrow: society can have more of one and less of the other but not more of both. Hence the purpose of much of the research was to quantify this trade-off. Comanor noted that the literature did not question whether this trade-off exists. Instead the research agenda prioritised finding an estimate of this trade-off, in the form of the ratio of the return (future health) on the original investment. Comanor identified three potentially relevant rates of return: the return to the firm in terms of economic rent from their investments; the return to the industry overall; and the social return, where return is measured as the increase in social welfare (economic rent and consumer welfare) from the investment in higher prices.

Comanor found that the focus on evidence of these rates of return was the single issue common to the disparate economic literature on the pharmaceutical industry. He also found that, at the time of his review (1986), no reliable estimate of the social rate of return on R&D had been published in the peer reviewed literature.⁶ Comanor concluded that it could be possible to increase competition (lower price) without having a loss in future innovation, however the current political economy excluded this possibility from the research agenda. Consequently, the evidence that could test this hypothesis (the possibility that there is no trade-off) was not available.

Comanor observed that during the period from 1959 to 1985, the political economy of the pharmaceutical industry was reframed at least twice in response to changes in the political debate. The focus shifted from questioning whether the industry did in fact experience monopoly rents, to accepting that they did and then considering the impact of regulation on these rents and the incentive for R&D. Comanor also noted that the adversarial nature of the political debate was reflected in the economic research. He notes that at the start of economists’ engagement with this political economy the focus was not on identifying critical trade-offs. Instead each side of the debate had a different premise, specifically, that the key issue was that competition should be restricted in order to maximise innovation and hence social welfare and the second ignoring this relationship.⁷

In the 25 years since Comanor’s 1986 review of the political economy of the US pharmaceutical industry, the following have continued to grow: the US pharmaceutical industry⁸; US expenditure on pharmaceuticals and health as a percentage of Gross Domestic Product (GDP)⁹; the number of new drugs in the US development pipeline¹⁰; and the average longevity of the US population.¹¹ Studies have provided further evidence that the following relationships are positive: new drug price and R&D investment by firms (Vernon 2005); R&D investments and new drugs, as summarised by the costs of bring a new drug to market (DiMasi 2001); and new drugs and longevity (Lichtenberg 2006). Furthermore, other evidence suggests that the costs of bringing a new drug to market continues to increase as does society’s demand for new drugs, particularly in relation to chronic diseases for which obesity is a risk factor (Grabowski et al. 2002; DiMasi et al. 2003).¹² The evidence supporting the case for higher new drug price appears to have strengthened, but the focus of evidence development has not broadened; the landscape of this political economy appears to have intensified but not shifted.

Since 1986, there have also been three main developments in the global pharmaceutical economy. First, institutions throughout the OECD started using formal processes such as HTA/CEA¹³ to assess the incremental costs and benefits of new drugs compared with the best existing therapy.¹⁴ The results of HTA/CEA are then used in conjunction with a decision threshold and other information to assess whether the population will be better or worse off if the institution reimbursed the drug at the firm’s offer price. Hence, the policy debate throughout much of the OECD is increasingly broader than that of the US debate. The latter is primarily concerned with policies around discounts to large purchasers, whether there should be universal access to drugs, and whether HTA/CEA should be used and prices regulated. The rest of the OECD is additionally concerned with the choice of decision threshold and the type of information that should be included in an assessment of costs and benefits of new drugs.¹⁵ However, the imperative to maximise the benefits of pharmaceutical and biotechnology innovation remains a significant part of OECD-wide research on pharmaceutical policy.¹⁶

Second, there has been a significant increase in the quantity of evidence about the relationship between: (1) price and innovation; and (2) new drugs in general and health.¹⁷ However, it was only comparatively recently that the US pharma-economic literature provided two estimates of the ratio of the social return on consumers’ investment in higher drug prices in the US. Lichtenberg’s 2004 estimate of the social return on additional investment in new drug R&D is in the order of 160:1. Santerre and Vernon’s (2006) estimate of a return on consumer’s investment via higher prices over the period 1960–2000, in terms of the value of the additional health benefits from additional drugs, is in the order of 28:1.

Third, the US pharmaceutical industry now has two additional avenues to take the PEND to the rest of the OECD: (1) the formal reimbursement process for individual new drugs (lobbying for choice of decision threshold) (Vernon et al. 2010); and (2) the bilateral FTAs between the US and OECD countries (lobbying to prevent trading partners from regulating new drug price) (Harvey et al. 2004).

US pharma-economists have sought to adapt the original US political economy and research agenda to accommodate some of these changes. For example, Vernon et al. (2009) chose to define the socially optimal threshold from the perspective of optimal innovation. The authors started with the premise that socially optimal decision investment in R&D occurs when the firm can appropriate 100 % of the associated social surplus. Vernon et al. argue that this result occurs when the incremental cost per quality-adjusted life year (QALY) of a new drug is the same as the incremental cost per QALY of the least cost-effective of currently funded services. The authors argue this reference is the provision of dialysis at a cost per QALY of $129,000. Other authors have argued that setting a price threshold of i ¹⁸ and comparing the results of CEA against this threshold of i is price control under another name and its result is the same: pricing below the free market price will lead to a deadweight social loss.¹⁹ Jena and Philipson have published a number of papers about the inclusion of dynamic welfare considerations in the decision threshold (Jena and Philipson 2007, 2008). Originally they argued that this threshold should be the maxWTP, just as Vernon et al. have claimed. Their rationale included that “technology adoption through cost-effectiveness is a price-control policy in disguise and might therefore have many of the properties of such policies.” However, in the later paper they recognised a number of factors that supported the case for the threshold to be lower than the maxWTP. These factors include budget constraints and the contribution by public sector research funds to pharmaceutical R&D. Jena and Philipson did not specify exactly what this price should be, only that it should be higher than the threshold applied to non-pharmacological therapies.

One key aspect of the political economy has remained constant, despite these developments: the trade-off between savings today and health tomorrow remains the central premise.²⁰ The possibility that increased competition (lower prices) could lead to more health in the future as well as today is not part of the research agenda. Furthermore, it is a possibility that continues to be excluded from the prevailing political economy.

This reframed political economy would focus on the central policy decision by a reimbursing institution: which decision threshold will maximise the npvPH? The first step in this research was to develop a formal model to define the political economy of new drugs in the context of policy choice and research. The model was used to specify both the current and alternative frames for the political economy.