Drug Companies Don't Get Enough Money …

… for the life-saving benefits that they provide us, according to an intriguing article in current issue of The Milken Institute Review (registration required). In their article, "Dividing the Benefits from Medical Breakthroughs," two University of Chicago scholars, Tomas Philipson and Anupam Jena, look at the case of HIV/AIDS drugs and figure out how much value patients get from the drugs versus how much value pharmaceutical companies get from the same drugs.

HIV/AIDS drugs increase an infected person's life expectancy by 15 years on average, which Philipson and Jena (using standard econometric techniques for figuring out the value of life years) calculate as being worth a total of $740,000 per infected person. They then sum up the total value over the number of people in the United States who have been infected and, assuming a steady annual infection rate of 20,000 per year, they conclude: "The aggregate value of the HIV/AIDS drugs for those infected and those who will be infected is nearly $1.4 trillion!"

How much do the drug companies get? They estimate that the lifetime sales revenues of HIV/AIDS drugs will equal $74 billion. Which means, according to Philipson and Jena, that "almost 95 percent ($1.33 trillion out of $1.4 trillion) of the economic surplus generated by the drugs went to consumers." That's right, consumers get 95 percent and drug companies get 5 percent!

Philipson and Jena cite other calculations that find that the value of the changes in life expectancy between 1970 and 1990 was $2.8 trillion owing to the development of other life-extending medical advances against infectious diseases and coronary artery disease.

Considering how valuable drugs are, Philipson and Jena then wonder if we could get more of them with better incentives to innovators. To wit:

The value to be had from life-extending and life-enhancing medical innovation is enormous. But, generalizing from the case of HIV/ AIDS drugs, the portion of the surplus ending up in the pockets of innovators is often modest—so modest that the division may be seriously retarding the pace of innovation. The big question, then, is whether politically acceptable ways can be devised to sustain high levels of private investment in high-risk medical projects that have the potential of huge payoffs for patients. The promise of modern medicine is vast. But the mechanisms for insuring that medicine delivers on that promise are not always up to the task.

Something to think about the next time you hear a politician demagoguing against "Big Pharma."

Disclosure: Yes, I do have some small stock holdings in various biomedical companies. I certainly hope to make a profit off of them, but I also believe in the good that they are doing. If you choose to invest in some random biomedical stocks because of what you read here, may God (or other deity of your choice) help you.