FALLACIES OF THE R&D ARGUMENT:

A Focus on AIDS and Neglected Diseases in Africa.

Name:

Nicola Ong H.C.

Module:

Intellectual Property Law. (LW556)

April 2002

Seminar Leader/Supervisor: Alan Story

Fallacies of the R&D Argument:

A Focus on AIDS and Neglected Diseases in Africa

Introduction.

The motivation for this dissertation is the alarming rate at which the AIDS virus is spreading, particularly in Africa where an estimated 34 million people are living with the disease, 19 million have died from it. [1] The cost of new anti-retroviral drugs developed by multinational pharmaceutical companies in the States which enable people with AIDS to live “relatively healthy lives”[2], is astronomical (about 10 to 16 thousand US dollars per patient per year). This is an impossible price to pay when the average income in South Africa is less than 1000 US dollars per annum and hence, only 0.001% of Africa’s AIDS patients receive anti-retroviral treatment.[3] This is outrageous considering that such drugs can be produced by the South African generic drug industry at a cost of 100 to 200 US dollars per patient.[4] These high prices are a result of strict enforcement of patent protection by multinational pharmaceutical companies. There are many well rehearsed arguments as to why such patent protection is needed generally, as well as specifically in relation to the pharmaceutical industry. However due to word constraints, I shall focus my attention on the ‘scare card’ of the pharmaceutical industry. Their argument is that;

if anything is done to moderate prices or profits, investment

in R&D expenditures will suffer.

In dealing with the industry’s argument, I shall show that despite numerous attempts at estimating the actual cost of developing a drug, figures vary wildly thus making it difficult to assess exactly how much profit is needed in order to encourage future R&D. It if fallacious to assume that only the cost of R&D is reflected in the price of a drug. The hidden cost of marketing is a great contributor to figures quoted. There are also other factors to be considered. I shall demonstrate that despite the additional (and in my opinion unjustified) costs included which hike up the price of drugs, the pharmaceutical industry is one of the most profitable industry in the world and hence well able to ensure continued R&D.

I will them move on to demonstrate that R&D is not solely dependant on incentives of patents and profit. But even if we accept that premise, given the current profits and status of the pharmaceutical industry, it will remain one of the most attractive industries for investment for a long time to come. Africa is a marginal market and a decrease in drug prices there will have little impact on overall revenues earned by drug companies. Furthermore, the industry gets help from the government through grants, tax credits etc. However, in relation to Africa, it is questionable if it make sense to provide incentive for innovation, when little effort is focused on development of drugs for diseases such as malaria and sleeping sickness, and where drugs are available (such as in the case of AIDS), people are unable to get access to them because of high prices charged.

How much does it cost to develop a new drug?

It is the argument of the pharmaceutical industry that the cost of R&D is high and the development process, lengthy. However, when asked to put a figure on how much it costs to develop a drug, we find that estimates vary wildly. Last year, Tufts estimated it to be a meteoric 802 million US dollars per drug[5] while the Association of British Pharmaceutical Industries puts the figure down to 350 million pounds[6]. In 2000, a figure of 500 million US dollars was extrapolated from a study done by Joseph DiMasi in1999[7] and backed up by Shannon S.S. Herzfeld, senior vice president of international affairs at Pharmaceutical Research and Manufacturers of America.[8]

The vastly differing figures are partly a result of non transparency of the industry and its unwillingness to allow any verification of their R&D figures. It is naive to assume that R&D is the only cost and in the following section I will highlight some hidden yet expensive costs before moving on to inspect the accounting assumptions used in determining the total cost of developing a drug. In doing so I will focus on the areas of public funding, government incentives and risk.

Marketing and other hidden costs.

Pharmaceutical companies would have us believe that they spend more on R&D than any other single budgetary item. However when asked to see the industry’s R&D records, the industry fought, and won a nine year legal battle to keep congressional investigators from the General Accounting Office away.[9] Why would the industry be so unwilling to allow their records to be inspected unless they had something to hide?

The pharmaceutical industry seems ever willing to highlight its most prominent statistic as being the quantum it spends on R&D expenditure, and boasts that 20% of its gross output is directed at R&D.[10] What the industry is more secretive about is how these figures relate to what it spends in other practices and the rate of return it receives on its investments.

Increasing literature has suggested that R&D does not top the industry’s budgetary list. Since the US government relaxed its rules on direct-to-consumer advertising in 1997, the US pharmaceutical industry has increased its advertising budget by an average of 40% each year.[11] A recent report done by Families USA concluded that all nine of the U.S. pharmaceutical companies examined spent more money on marketing and advertising than they did on R&D while 8 out of the 9 spent more than twice as much.[12] From pencils inscribed with the company’s name to all-expense-paid trips to exotic locations, these are just a few of the marketing practices which contribute to the high prices of drugs.

One suggested solution to curb the amount spent on marketing would be to limit the amount a company spends on promotion to a certain percentage of its revenue. For British firms, the limit is set at 9% and Canadian firms have similar regulatory restrictions under their Patent Law.[13] However I believe that in order for this to be effective, stricter regulations are needed to hold companies to account and to ensure that the government can call for records and accounts to be inspected.

A common defence in relation to extreme marketing strategies, is that drugs have a short ‘effective patent life’ due to the lengthy time it takes to develop a drug.[14] Pharmaceutical companies have only a small window of opportunity to recoup research expenses, hence they have to market their product aggressively. This would seem logical from a business standpoint if not for its indulgence in other practices such as compensation packages and lobbying practices, which I will illustrate below.

Another area highlighted by the Families USA report, is the amount spent on compensation packages for top pharmaceutical executives. The executive with the highest compensation package in the year 2000, exclusive of unexercised stock options, was William C. Steere, Jr., Pfizer's Chairman, who made $40.2 million.[15] And invariably, such spending is also passed on to the consumer in the form of high drug prices.

Economists have suggested that lobbying practices have also contributed to the high price of drugs. In 1999-2000 the drug industry spent 262 million US dollars on federal lobbying, campaign contributions and advertising for candidates.[16] It thus comes as no surprise that although it was within the power of Congress to subpoena the R&D records, it failed to do so. Such expenditure could be seen as a shrewd and a politically wise move on the part of the industry. However, it does not negate the fact that such practices are financed by the public, (through elevated drug prices), while delivering no real health benefit. Such sums would go a long way towards financing R&D programmes, especially in the area of neglected diseases.

It would seem rather illogical that a company desperate to recoup research costs incurred in the short ‘effective patent life’ which it has, would be so willing to incur hefty expenses elsewhere. In other words, why would a company which is desperate to recoup R&D expenses burden itself further by spending on compensation packages and lobbying practices which do not affect the direct sale of the product?

While the pharmaceutical industry blames noble research and development costs on the high price of medicine, it still remains one of the most, if not the most profitable industry, with profit margins in 2000 that were nearly four times the average of Fortune 500 companies and pays its stockholders the highest percentage of company revenues. Thus "if meaningful steps are taken to ameliorate fast-growing drug prices, it is corporate profits, expenditures on marketing, and high executive compensation that are more likely to be affected, not research and development."[17]

The pharmaceutical industry continues to defend its lavish pricing practices by alleging that those prices are needed to sustain R&D. The pharmaceutical industry’s response in this regard is extraordinarily misleading. To suggest that any moderation in drug prices would reduce R&D ignores the fact that future profits of pharmaceutical companies are dependent on the development of new drugs. As a result, these companies cannot afford to de-emphasize R&D.

Public funded labour (Taking credit for things they do not do)

While in some cases, a company may do all of the important stages of research and development for a drug, including clinical and pre-clinical investments, this scenario is rarer than pharmaceutical companies would have you believe, especially in the case of AIDS and ‘poor people’ drugs. In such cases, it is more likely that governments or private donors fund important parts of research.

The vast majority of drug companies do not start from scratch in the production of a drug. Instead, “this research is based, in great measure, on the ideas and innovations of those who have worked previously in a particular research area or related ones…. It is the existence of a healthy and accessible public domain in scientific information that provides the main source for private R&D on pharmaceuticals.”[18]

A classic example of the above is the development of AZT (the first AIDS drug) which was discovered in a publicly funded National Cancer Research Institute. When it was deemed too toxic to be used in the treatment of cancer, its patent became part of the public domain after it had expired. However, it was later adopted by Burroughs Wellcome and put forward as an AIDS drug and subsequently proved useful in blocking AIDS virus reproduction.[19]

Soon after AZT had been introduced into the market, congressional hearings were held in order to question Glaxo-Wellcome’s high pricing of the drug. They presented an inadequate account providing a figure of 231 million US dollars as the cost in developing the drug. This figure included “the cost of pre-clinical and clinical trials, data collection and monitoring” and was based on a “ten to twelve year development period”.[20] This statement is highly misleading as it was the government that had carried out all initial testing and so Glaxo only had to spent 2 1/2 years on testing until the drug was approved for marketing. Hence the actual time spent on clinical trials was cut by up to 80%.

The amount of time take is very important because an estimate of the cost of developing a drug would include the opportunity cost of capital and the investments are increased at a compound rate of interest.[21] Hence if the amount of time the government spent in developing the drug were shaved off, the estimated cost would fall drastically and the figure of 231 million US dollars becomes a farcical over inflated myth.

This also casts further doubts on the argument of the pharmaceutical industry that they are forced to market aggressively due to the short ‘effective patent life’ of a drug. For example, in the case of the drug AZT, Glaxo would have increased its ‘small window of opportunity’ by about 8 years or more. Such high prices become unjustifiable as drug companies have a much longer period than claimed to recoup their costs of marketing which in fact provides no health benefit to consumers.

Timing is also important because since drug companies only enter at the tail end of the R&D process, the final drug development is largely conducted according to their own priorities, i.e. the best means to make profits. It is clear that the pharmaceutical industry cannot be relied upon to develop effective and reasonably priced drugs which are needed by the millions of poor people in Africa who are suffering from AIDS and neglected diseases.

This dire lack of drug R&D into unprofitable diseases is demonstrated in new data showing that between the period of 1975 and 1999, although 1393 drugs were developed, only 1% of them (13 drugs) were specifically for tropical diseases which mainly affect he developing world.[22] Out of this 13, only 4 were the product of drug companies and 2 were slight variations of existing drugs.[23] It is generally less expensive and time consuming to develop a variation of a drug than a new one because the risks and costs are less. Such drugs are often referred to as ‘me-too drugs’. In the case of AZT, once it was identified as effective in the treatment of AIDS, there was a rush to test other similar inhibitors. Again the initial efforts funded through the public purse research contributions of public funded scientists are very rarely acknowledged and are being claimed as the pharmaceutical industries own.

According to the NIH, taxpayer-funded scientist were responsible for 55% of the R&D which resulted in the discovery and development of the top 5 selling drugs in 1995.[24] This figure is greatly increased when we consider that the public funding is mostly used to compensate for the lack of R&D in non- ‘blockbuster” drugs. Thus if we look at R&D in the industry as a whole, drug companies only really make a minority contribution.[25]

In effect what is happening is that consumers are being charged twice. First by paying in the form of taxes or charitable contributions toward research and again in the form of excessively high price tags on drugs. Some have argued that such drugs should be classified as ‘quasi-public’ goods and so there should be some public sharing of the profits.[26] One method by which this can be done is to force pharmaceutical companies to reimburse the government where public funding has contributed to the development of a drug. The Federal Department of Energy in the US as already operating on such a system[27] and I agree that given appropriate guidelines such a system could work in the pharmaceutical industry. This would allow the government more money to invest in research areas currently neglected by the drug companies.

Government incentives: A focus on tax credits.

In addition to funding that the government provides for R&D, other incentives such as tax credits and grants are given. Thanks to tax credits, the industry’s effective tax rate is about 40% less than the average of all other industries.[28] There are also specific tax credits given for research in specific areas such as clinical trials for orphan drugs, vaccine research and testing the effect of drugs on children. The last incentive is called paediatric exclusivity and is estimated to amount to 600 million US dollars in additional profits per year for the drug industry. [29]

One of the main criticisms of a general tax credit system is that there is little knowledge or control over what development programmes the credits are applied in. Thus there still may not be enough focus on the development of AIDS drugs or other drugs for neglected diseases.[30] Targeted tax credits, such as the ones mentioned above may go some way towards solving this problem. However, the lack of accountability and regulation in the field has resulted in a non transparent R&D process and the public not being informed as to what the credits are used for. Although an estimated 1 billion US dollars was spent in 1996, an NIH official admitted that the NIH actually has no idea how much was give out in grants annually.[31]As a critic of the NIH claimed ‘they’re in the business of pouring out money into private industry and failing to keep track of it, we’re talking about millions of dollars wasted and about people being exploited because of excessively high drug prices’. [32] Indeed if government organisations who dispense these subsidies are unsure as in fact how much is given, how easy it must be for drug companies to simply quote the net cost of the cost in developing a drug without acknowledging government contributions.

Furthermore, just to add salt to the wounded pockets of consumers, not only are R&D costs tax deductible, so too are the extravagant marketing costs we dealt with above.[33] So although the government has subsidised the development process, and public funding has played a significant role in R&D, drug companies are still including these costs (which it did not have to bare) in the bill as well as sneakily adding on marketing costs as well even though they provide no health benefit. This overly inflated figure is then represented in the bitter high cost of drugs which we swallow under the sugared pretext that if anything is done to moderate prices or profits, R&D will suffer thus harming millions of people with life threatening conditions.[34] And if this all does not already seem like a conspiracy to rip of the public, I will demonstrate below how there is another exaggerated factor that drug companies have taken into consideration; that of risk.