Steven Maurer

Practically all commercial drug development is driven by patents. Unfortunately, this business model assumes a multi-billion dollar market which often doesn’t exist. This is almost always true for developing-world diseases like malaria and dengue fever. Here, patients are so poor that even millions of sufferers don’t add up to a useful market. But inadequate market size is also surprisingly common in rich nations. Probably the most famous example involves orphan diseases that “only” affect a few thousand patients — a category that happens to include most cancers. More generally, rich nation markets repeatedly undervalue goods which (a) have externalities, so that consumers only receive a small part of the product’s overall benefit to society, and (b) are too important to fail, so that consumers calculate that government will eventually supply them gratis. Together, these market imperfections go a long way toward explaining why US companies invest so little in vaccine R&D.

For many diseases, then, patents are not an option. But if patents won’t work, then what? Recent years have seen several high-profile initiatives to fill the gap. The first – and easily the largest – was Congress’s $5.6 billion “Bioshield” program (Public Law 108-276) to promote the private development of drugs and vaccines to fight off a bioweapons attack. Five years on, the program hasn’t delivered a single new product. Bioshield’s defenders like to argue that drug discovery is expensive – about $800 million per drug. By that standard, though, the program’s $5.6 billion budget should funded seven new drugs. The real problem, as critics have repeatedly pointed out, is that Bioshield got the incentives wrong. “Wait for industry to invent a new drug,” Congress told DHS, “and then pay them a reasonable price to make it.” Companies, though, were skeptical. To them the Bioshield law sounded more like an invitation to spend $800 million and then trust the government to set a “fair price.” Not surprisingly, they stayed away in droves. Evidently, just offering money isn’t enough. You also have to get the incentives right too.

More recent initiatives have taken this lesson to heart. When Congress passed the 2006 Pandemic and All-Hazards Preparedness Act (Public Law 109-417) it debated at least a half-dozen possible incentives. Wisely, it didn’t pick any of them. Instead, it gave a new agency (the “Biomedical Advanced Research and Development Authority” or “BARDA”) broad authority to offer prizes, milestone payments, and almost any other reward it thought would work. The new focus on incentives also spread to the private sector where, for example, the Gates Foundation has spent enormous amounts of time debating prizes, non-profit drug development teams, and other options.

In a way, all this debate is encouraging – As the American poet Marianne Moore once remarked, “It is a privilege to see such confusion.” The really hard part, though, will be deciding which of the many possible incentives to use. Today’s policymakers typically avoid this issue by saying that they “want to experiment” with many different incentives. But this isn’t really practical. At $800 million per drug, the country can’t afford many more Bioshield-type “experiments.” Worse, almost all incentive schemes have strong economies of scale. This counsels putting all of our eggs in one or, at most, a few baskets. Dividing funds across many small “experiments” just doesn’t make sense.

During the Bush Administration, incentive design (witness Bioshield) was almost entirely a matter of intuition and guesswork. Indeed, most staffers actively resisted any kind of detailed discussion, let alone asking advice from professional economists. (I remember at least three occasions in which twenty-something staffers told me that they already knew how to procure innovation and just weren’t interested.) Here’s hoping that President Obama’s people will do better. But this brings us to the $64 question: Suppose that BARDA wants to make a rational, evidence-based choice between, say, prizes and an in-house drug development team. How should they go about it?

Clearly, this topic is much too large for a blog. Still, it is easy to provide a short sketch of the arguments that BARDA might want to consider when choosing between prizes and an in-house drug development team. Begin with the well-established observation that all incentive schemes are imperfect. Then our goal should be to choose the least imperfect incentive for each individual problem. In the case of prizes, the biggest imperfection is that there is no good way to know how big the reward should be. You might think that the reward should be just large enough to cover the drug company’s expected R&D costs, say $810 million. But there’s a problem: If you go to the underlying literature, the $800 million number isn’t a single number at all – It’s “$800 million ± $115 million.” This uncertainty means that BARDA will have to offer a much larger prize, say, $920 million to be sure that companies will invest.

The bottom line, then, is that a BARDA prize program can expect to overpay by at least 14% (and more likely 20-30%) on average. Clearly, then, BARDA should only adopt prizes if the alternative – an in-house development program – is even less efficient. Here, too, it is easy to find evidence. One simple possibility would be to study the US Army’s experience in developing vaccines in the 1970s and 1980s. Was this effort really less cost-effective than private firms during the same time period? If so, was the inefficiency large enough to wipe out the 20-30% overpayment associated with prizes?

I don’t know if the foregoing analysis will appeal to President Obama’s staffers. Here’s hoping that they – or my academic colleagues – can do better. Anything is better than having the country slip back into the bad old days when programs like Bioshield were designed on the basis of “gut checks” and bumper stick ideology. Politicians like to think that allocating money is synonymous with getting things done. Millions of US and overseas patients know better. In the end, the only thing that really matters is discovering drugs and vaccines that didn’t exist before. Spending money isn’t enough. We also need to be clever.

Stephen Maurer is Director of the Information technology and Homeland Security Project at the Goldman School of Public Policy.

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