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Public and Private R&D Spending
Health-related research receives the second largest amount of federal support for R&D (behind only defense-related research). That support has been steadily growing for several decades. Research spending by NIH—by far the primary recipient of government funding for health-related basic research—totaled $5.8 billion (in 2005 dollars) in 1970, more than doubled to $12.3 billion by 1990, and reached $28.5 billion by 2004 (see Figure 4-1). In comparison, R&D spending reported by the members of the Pharmaceutical Research and Manufacturers of America was just two-thirds the size of NIH’s spending in 1980. PhRMA’s R&D spending surpassed NIH’s in 1987 and has remained higher since then, although both grew at similar rates in the late 1990s and early 2000s. Much of the government’s R&D spending is for basic research, but a 1993 study by the Office of Technology Assessment found that some of it has funded applied research specifically related to the development of new drugs. OTA identified multiple federal programs, many of them at NIH, “whose specific mission [was] to con-duct R&D involving actual or potential pharmaceutical products.”4 At that time (in the late 1980s), federal spending on such research amounted to slightly less than 10 percent of the government’s total spending on health-related R&D.5 However, much of the rest of that spend-ing supports pharmaceutical R&D by improving the understanding of disease mechanisms. Although it is difficult to say exactly how much of the federal government’s health-related R&D spending is relevant to the pharmaceutical industry, much of it probably is. The rationale for government funding of basic scientific research is that if such research were left solely to the private sector, too little of it would be done, in the sense that the benefits to society from doing additional basic R&D (beyond what firms alone would conduct) would far out-weigh the costs. A company’s incentive to invest in R&D is limited to its own expected returns. In the case of basic research and development, those returns can be particularly low compared with the social benefits, because it can be difficult for private companies to capture more than a small fraction of the total social value of their basic research.6 Although the distinction between basic and applied R&D is not always clear, it is useful to think of basic research as generating information or knowledge that is not readily embodied in physical products. Companies can have trouble keeping the benefits of their basic R&D to themselves because the information can generally be communicated at very low cost Given the increasingly scientific basis of drug development, the pharmaceutical industry has come to view publicly funded basic R&D as a “critically important source of immediately useful knowledge and techniques.” Drug firms cite “immediate access to leading-edge publicly funded science” as an important competitive advantage. Government funding for basic research also pays for the laboratory training that graduate students receive as they prepare for careers as professional researchers in the pharmaceutical industry. Despite the difficulties of capturing more than a small part of its value, many drug companies perform some basic research themselves. In addition to supporting their applied R&D programs, such research helps to attract motivated scientists who might otherwise prefer to work in an academic setting. Doing its own basic research and publishing the findings may also enhance a firm’s capacity to benefit from academic and government basic research.
Does Government R&D Crowd Out Private R&D?
Even as it produces substantial social benefits, federal spending on basic research and development can also dis-courage private investment in R&D. Such crowding out can occur directly, as when the government sponsors research that the private sector would otherwise have conducted. Or it may occur indirectly, as the government competes for trained scientists and other scarce resources and bids up their prices. Government-sponsored R&D can also influence competitive interactions between firms. As a result of its own research and technical capabilities, one company may be better positioned than its rivals to take advantage of new scientific findings from government-sponsored basic research. Or the research may help competitors narrow a leading firm’s advantage by expanding the scope of common scientific knowledge. In either case, public funding of basic research can affect private R&D spending by revising firms’ expectations about profits.
Examples of Crowding Out
In the past, direct crowding out may have been relatively uncommon in the pharmaceutical industry because the public sector mainly focused on basic research and the private sector mainly concentrated on applied research and development. However, structural changes in the industry have increased the private sector’s role in basic research. And advances in biological sciences have helped to blur the distinction between basic and applied research.