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The data series starts in 1980 and ends in 2003. It includes only research and development conducted in the United States on drugs that have not yet reached the market. Data for 1980 to 1998 come from the National Science Foundation table “Company and Other (Except Federal) Funds for Industrial R&D Performance, by Industry and by Size of Company: 1953-98,” available at www.nsf.gov/statistics/iris/ search_hist.cfm?indx=10 (see the row for “Drugs and Medicines”); data for 1999 to 2003 come from National Science Foundation, Division of Science Resources Statistics, annual “Research and Development in Industry” tables, available at www.nsf.gov/statistics/industry (see the rows for “Pharmaceuticals and Medicines”). The National Science Foundation’s estimates also exclude spending on phase IV clinical trials (which are conducted after a drug has reached the market) and on the development of manufacturing processes—both of which PhRMA counts as R&D. In addition, NSF’s figures do not include R&D by pharmaceutical firms that sell their own products, if sales activities account for the largest share of their payroll. (The Census Bureau classifies such firms as part of the “wholesale trade” sector.)4 NSF estimates that postmarketing expenditures have recently constituted nearly 20 percent of PhRMA’s total.5 With those expenditures and drug R&D by “wholesale trade” firms included, NSF’s total for 2003 would be within $1.7 bil-lion, or about 5 percent, of the PhRMA estimate. Much of the remaining difference can be explained by PhRMA’s inclusion of some overseas R&D spending. Those differences aside, the rise in research and development spending in both sets of estimates partly reflects an increase in the average R&D cost per drug that is attributable to a variety of factors. The scope of drug research has greatly expanded, fueled not only by growth in sales revenue for drugs but also by advances in basic science.
4. NSF uses Census Bureau classifications and says that “true drug manufacturers are often assigned to the wholesale trade industry” because of a trend toward drug firms selling their own products. See Raymond M. Wolfe, Increase in U.S. Industrial R&D Expenditures Reported for 2003 Makes Up for Earlier Decline, National Sci-ence Foundation InfoBrief (December 2005), p. 4, available at www.nsf.gov/statistics/infbrief/nsf06305/nsf06305.pdf.
5. Personal communication to the Congressional Budget Office by Raymond Wolfe of the National Science Foundation.
The number of drug targets (typically, a protein molecule on which a drug is intended to act) has gone from 500 to more than 3,000 in recent years, and according to one analyst, “the expansion of research activity to investigate them is a natural . . . consequence.” The same scientific advances have also induced a shift from “chemistry-based” drug development to drug research based on molecular biology, which has led pharmaceutical firms to spend more for capital equipment and training. Further, in the wake of a 1980 decision by the U.S. Supreme Court governing the patenting of living organisms, bio-logical molecules can now be patented. That development has created a marketplace for basic research in the biological sciences. Consequently, pharmaceutical companies now often pay for access to basic research per-formed by specialized firms—research that traditionally would have been conducted in the public domain. Those additional research expenses have contributed to drug firms’ higher R&D spending, even though the net cost to society of that research has not necessarily changed.
R&D Intensity
The pharmaceutical industry is one of the most research-intensive industries in the United States. Pharmaceutical firms invest as much as five times more in research and development, relative to their sales, than the average U.S. manufacturing firm. Because increases in spending on drug R&D have been nearly matched by increases in revenue from drug sales, the industry’s R&D intensity—the ratio of research and development spending to total sales revenue—has not risen to the extent that R&D expenditures have. Over the past 25 years, R&D intensity has grown by about 50 per-cent. Most of that growth occurred in the 1980s; since then, the industry’s R&D intensity has hovered around 19 percent, according to PhRMA.
7. See Iain M. Cockburn, “Is the Pharmaceutical Industry in a Productivity Crisis?” (paper prepared for the National Bureau of Economic Research’s Innovation Policy and the Economy Conference, Washington, D.C., April 19, 2006), available at www.nber. org/books/innovation7/cockburn4-29-06.pdf; and Iain M. Cock-burn, “The Changing Structure of the Pharmaceutical Industry,” Health Affairs, vol. 23, no. 1 (January/February 2004), p. 12.
8. Diamond v. Chakrabarty, 447 U.S. 303.
9. Substituting private payment for public funding of basic scientific research may have a cost to society if it affects the pace or direction of that research; otherwise, it simply transfers the responsibility for paying for the research from the public sector to the private sector. A relatively close relationship exists between drug firms’ current R&D spending and current sales revenue for two reasons. First, successful new drugs generate large cash flows that can be invested in R&D (their manufacturing costs are usually very low relative to their price). Second, alternative sources of investment capital—from the bond and stock markets—are not perfect substitutes for cash flow financing. Those alternative sources of capital are more expensive because lenders and prospective new shareholders require compensation (in the form of higher returns) for the additional risk they bear compared with the firm, which has more information about the drug under development, its current status, and its ultimate chance of success. The National Science Foundation also estimates that the R&D intensity of the pharmaceutical industry has been fairly stable in recent years, ranging between about 8 per-cent and 10 percent since 1985. That estimate is less than half of PhRMA’s, in part because NSF includes less-R&D-intensive products not related to prescription pharmaceuticals (such as vitamins, over-the-counter drugs, reference chemicals sold to researchers for experiments, and consumer and animal care products). Even at that lower estimate, pharmaceuticals ranked as the most R&D-intensive industry in the U.S. manufacturing sec-tor for most of the 1990s, according to NSF (until it was overtaken by communications equipment, whose R&D-intensity was 12.7 percent in 2003).
The relative stability of the relationship between pharmaceutical R&D and sales revenue suggests that firms find it most profitable to invest any additional dollar of sales revenue in their own drug research. However, changes in real drug prices can affect companies’ R&D intensity or their propensity to invest in R&D from their revenue.12 The reason is partly that, as noted above, higher drug prices tend to increase firms’ cash flow, and internally generated cash is a relatively inexpensive source of investment capital. But changes in price levels also affect firms’ expecta-tions about profits. Thus, higher real drug prices may increase the value of completing existing projects more quickly and encourage companies to undertake more new research than they would otherwise. Both effects involve increased R&D spending and thus greater R&D intensity. Analysts generally view that connection as having clear implications for efforts to reduce industry prices and profits, in that such interventions would dampen R&D investment.