Friday, March 4, 2011

More on the Light and Warburton article on Drug Costs

I don’t want to be a blogger that leaves negative comments unaddressed in the comments section, so I want to bring up two good comments to my post on the Light and Warburton article.

First – actually, I shouldn’t have said anything about 11% being a high cost of capital. I certainly don’t keep track of what a reasonable cost is. It could be 20%, for all I know ;)

Second – Norman Siebrasse, who keeps an excellent blog SUFFICIENT DESCRIPTION, comments

But it does seem to me that including the cost of capital is appropriate. If the return to a pharma company cannot cover the cost of capital, then it won't raise the capital, and the research won't get done. To my mind, the reason we want to know drug costs is to know whether the need to promote the research justifies the high price. If that is right, then surely the costs that are essential to the research being undertaken must be included. The authors say "Calculating the cost of capital is a widely accepted exercise to determine whether a project
should be undertaken; but as a claim on public money or citizens’ cash, it is unreasonable." The authors seem to agree that if the cost of capital is not covered, the project will not be undertaken. I don't understand why they say incuding these costs is unreasonable. So far as I can see, they do not offer any argument at all on p. 8, where the point is discussed at greatest length - it looks to me like an unsupported assertion.

As is often the case, Norman’s comments stop me in my tracks and cause me to re-assess.

My initial reaction was to agree – but then to express doubt that the pharma industry is making this clear when they recite a big cost of R&D number.

But that strikes me now as too glib. Norman is right – cost of capital is a reasonable thing to include in “drug costs” if one wants to know if we are providing enough protection (as opposed, maybe only in my mind ;) , to “R&D costs”).

I re-read that section in the Light and Warburton article. I think a key part of their position is

In other industries, huge investments to develop new products, like a new chip from Intel,
do not lead firms to make the argument for government-protected prices by claiming that
‘You owe us for all our R&D costs, plus what we would have made had we not undertaken
the project in the first place’.

In other words, Light and Welburton want to know why cost of capital makes a case for supporting more protection for a pharmaceutical company than a computer chip company (or whatever). Presumably, all innovative industry needs to cover the cost of capital.

1 comment:

Norman said...

By "government protected prices" the authors seem to mean patent protection. If that is what they mean, then there are two answers to this point. First, a new chip from Intel is indeed protected by patents. Secondly, the empirical evidence is very clear that patent protection is far more important to the pharmaceutical industry as a means of recovering R&D costs than it is to the semiconductor industry.