To Increase Innovation and Make Drugs More Affordable, Deregulate


David R. Henderson: Graduate School of Business and Public Policy, Naval Postgraduate School, Monterey, CA.; Hoover Institution, Stanford University, Stanford, CA.

Charles L. Hooper: Objective Insights, Inc., Grass Valley, CA.


Dr. Henderson reported no financial interests. Mr. Hooper is an employee of Objective Inslghts, which has provided consulting services to Alcobra, Altos Therapeutics, Biogen, Cerevast, Dynavax, Gilead Sciences, Impax Labs, Ismed, Jazz Pharmaceuticals, Novo Nordisk, Prothena, TesoRx, and Xenoport. Mr. Hooper also owns stock in Depomed, Express Scripts, Five Prime Therapeutics, Geron, Gliead Sciences, Jazz Pharmaceuticals, Merck & Co, TesoRx, Vivus, and XenoPort.

Key Words

Are there ways to make drugs more affordable without reducing the incentive to innovate?

Dr. Owens makes two principal claims with which we agree. Any dialogue about the rising cost of cancer drugs must, as the author says, “focus on how to preserve innovation in the industry while maintaining access to affordable drugs.” We should also, as the author writes, avoid “actions that may ultimately be counter-productive.”

Given the nature of modern drug development, some degree of patent protection is necessary. As economists who study patents recognize, there is a tension between preserving innovation in the pharmaceutical industry and making sure that drugs are affordable. The reason is simple: a drug company deciding whether to invest in research and development for a drug needs a substantial incentive to make the large upfront cost worth bearing. The incentive is the high revenue the company can earn from the high prices it is able to charge for a successful drug for the period between the date the US Food and Drug Administration (FDA) approves the drug and the date the patent expires. Without patent protection, the incentive to bear those costs and develop a drug would be reduced dramatically.

Are there ways to make drugs more affordable without reducing the incentive to innovate? There are two such ways: the first is to substantially loosen the rules for drug approval by the FDA, and the second is to allow drug companies to sell drugs at lower prices than they charge to Medicaid.

Redefining The Role Of The FDA

The first, and, in our opinion, more effective means of reducing drug prices is to make it easier for drug companies to introduce new drugs to the market. Under current legislation, all drugs are essentially illegal until the FDA approves them. Drug companies cannot get approval simply by showing that a drug is safe; they also must show that it is efficacious when used at a particular dosage for a particular ailment. Moreover, in recent years the FDA has required larger and larger groups of patients to be tested.

All of this is extremely costly. In 2003, DiMasi et al.1 estimated that the total cost of a successful new drug was $802 million. Christopher P. Adams and Van V. Brantner2, an economist and a research analyst, respectively, at the US Federal Trade Commission, tried to replicate this figure in 2003, using different data, and found the cost to be slightly higher—$868 million. More recently, DiMasi et al.3 estimated that the cost to bring a drug successfully to market is $2.558 billion, a number that seems reasonable given the previous estimates and the methodology used. Why is this number so high? It is because so much of research and development is spent on drugs that do not make it to market. In reaching their conclusion, DiMasi et al.3 take account of the probability that a drug will actually make it to market. That way, they include all the “dry holes”: the drugs that didn’t work at all, the drugs that were too unsafe, and the drugs that were not efficacious enough. 

We argue that the cost of bringing a new drug to market would fall substantially if drug companies did not have to depend on FDA approval. There are two simple changes that could be made, while still retaining the FDA. The first is to denationalize drug approvals by granting international drug approval authority to a dozen or so respected government regulatory bodies around the world, such as the European Medicines Agency and the Health Products and Food Branch of Health Canada. The FDA and Health Canada approve drugs using similar methods and with similar objectives; why should residents in Bellingham, WA, be given access to new drugs potentially years after their neighbors in Vancouver?  

As Daniel B. Klein explained in an article for the Library of Economics and Liberty: “Under the proposal, the FDA would have to compete in giving permission” (italics in original).4 Safety and efficacy would still be paramount, but regulatory agencies would compete on cost, efficiency, and reasonableness. Government agencies are non-profit institutions, but they often charge pharmaceutical companies a fee for considering their drugs for approval. For instance, in the United States, the FDA’s Prescription Drug User Fee Act (PDUFA) fees can total $2-3 million per approval.5 Such fees may be lower in other countries. Additionally, delays and unneccessary clinical trials result in even greater costs to pharmaceutical companies. For a drug that will have sales of $365 million per year, for example, every day of delay costs the producer of that drug $1 million. Additionally, the cost of conducting clinical trials can total tens or hundreds of millions of dollars. Therefore, the cost of bringing a drug to market would be greatly reduced with a speedier approval process and reduced clinical trials requirements.

One may reasonably inquire about the incentives for these regulatory agencies to compete for the opportunity to grant drug approvals. In addition to competeing on the basis of revenues from fees, such as the PDUFA fees, agencies would also compete for reasons of status and organizational power. The latter motivation has been supported by research on the concept of public choice, which proposes that even those who work in government agencies are motivated chiefly by their own self-interests.6

The second change we propose is to allow drug companies to sell drugs that are not FDA-approved as long as the drug company states clearly, in large letters, in the package insert and on the container in which the drug is sold, “This drug has NOT been certified by the FDA.” Pharmacists could help disseminate this caution. This second reform sounds radical; but it can actually make all patients either better off, or at least not worse off, by their own standards.

Patients can be divided into two categories: (1) those who insist on FDA certification of any drug they take, and (2) those who are willing to take drugs that are certified by non-FDA certifiers. These non-FDA certifiers could include: U.S. Pharmacopeia, U.C. Berkeley Wellness Letter, Consumer Reports, Drug Facts and Comparisons, medical journals, the multitude of guideline-setting bodies (e.g., American Academy of Pediatrics, American Thoracic Society, National Comprehensive Cancer Network, National Kidney Foundation, and American Heart Association), the Agency for Healthcare Research and Quality, and even HMOs, hospitals, health insurers, or patients’ doctors. These organizations review the available evidence and, using a variety of criteria, make recommendations about which drugs are safe and efficacious for various conditions and which ones aren’t. Indeed, many of these organizations are more knowledgeable about diseases and their treatments than FDA employees. Drugs that are approved by any of these other certifiers, but not by the FDA, will not be taken by patients in the previously described first category; therefore, they will be neither better nor worse off under the new proposed system.

But consider patients in the previously described second category. These patients will not have to wait for a drug to be approved by the FDA before they can take it. Therefore, some drugs will be available to them more quickly. Therefore, these patients, by their own standards, will be better off. One might argue that people should not be allowed to take drugs that have not been approved by the FDA. But a large majority of Americans now take drugs that the FDA has not certified; we refer to off-label uses of drugs. An off-label use is a use of a drug that the FDA has not approved for that particular use. Off-label prescribing is legal,7 widely practiced, and actively encouraged by Congress,8 the National Institutes of Health,9,10 Medicare,8 the Veterans Administration,11 and the National Cancer Institute.12

Indeed, a large percentage of the uses of drugs are off-label.8 Consider gastroparesis, a poorly understood upper gastrointestinal disorder in which the contents of the stomach do not move efficiently into the small intestine. Diabetics are particularly susceptible to this condition,13 for which there is only one FDA-approved drug: metoclopramide. Physicians have discovered that another drug, erythromycin, an antibiotic, helps reduce nausea, vomiting, and abdominal pain for some patients. Although erythromycin is not FDA-approved for gastroparesis, it unquestionably helps patients with this condition.14

Off-label uses in oncology can reach 90% of all treatments.12,15 There are some diseases for which there are no approved therapies; in those cases, 100% of the uses are off-label. For example, amyloid light-chain amyloidosis, for which there are no approved medicines, is often treated with medicines approved for related diseases, such as multiple myeloma.16 If it makes sense to allow people to use drugs for off-label uses, then it also makes sense for them to use drugs that the FDA has not approved for any use. Concerns about the potential toxicity of drugs not approved by the FDA could be addressed by instituting a requirement that all drugs at least complete a Phase I clinical trial before being brought to market.

That makes our suggested reform what economists call a Pareto improvement: an action that harms no one and helps at least one person.17 Few potential reforms would make some people better off while making no one worse off; we should implement those few.

How would these reforms accomplish the goal we began with: encouraging innovation while keeping drugs affordable? With the possibility of marketing and selling drugs without FDA approval, drug companies would face a lower upfront cost of bringing drugs to market. In turn, there would be more innovation. A lower cost required to move drugs through the research pipeline would mean that more drugs would make it to the market and, thus, would be available to patients. A drug that otherwise would not have been available at all, or would have been available later, could make an enormous difference to patients and even potentially save lives.

As for the goal of making drugs more affordable, lowering the costs of research and development alone would not necessarily cause drugs to be cheaper. From the perspective of a profit-maximizing company, these costs are sunk and will be regarded as irrelevant in setting prices. The company will set the price of a drug based on what the market will bear.

But now consider another positive effect of our reform: increased competition. With a lower cost of research and development, some new drugs that would otherwise not have existed or would have come later will compete with existing drugs. Some of these drugs would be cheaper than the existing drugs with which they compete. With more available products on the market, some companies, in an effort to gain market share, will price their drugs lower than existing competitors. Additionally, drug companies could justify higher prices for approved drugs that underwent the FDA drug approval process. As a result, those drugs that are not FDA approved might be priced lower in an attempt to compete better with drugs that are FDA approved. This competition will put pressure on sellers of FDA-approved drugs to lower prices, or at least not raise them as much.

Some of these drugs may only be marginally valuable in terms of safety and efficacy, and their development may be justified only if the costs of research and development are lower. Because they do not represent significant breakthroughs, some critics might disdainfully refer to these additional drugs that are brought to the market as “me-too drugs.” However, by the same standard, a Chevrolet is a me-too Ford. Just as competition from Chevrolet makes Ford prices lower than they otherwise would be, these drugs will put downward pressure on the prices of other drugs. And choice increases the probability that physicians will find a drug that works for their patients.

Deregulation of Price Controls

We propose a second means of lowering the cost of prescription drugs: eliminate the regulation requiring drug companies to sell to Medicaid at the lowest price that they offer to anyone.18 This regulation appears, on its face, to make patients and taxpayers better off, because it assures low prices for Medicaid. What is unseen is how the regulation leads to higher prices for cash-paying patients and for relatively low-income people who do not qualify for Medicaid. Consider a drug that costs $30 to produce. The drug company is able to sell this drug to Medicaid for $100. However, there could be a pocket of consumers not covered by Medicaid who would be willing to pay $55 for this drug. The drug company could therefore make a profit by charging these patients $55. The patients would be better off, and so would the drug company. But, under current regulations, the drug company would not offer the drug to this market for $55, because, if it did so, it would have to sell to Medicaid for $55, rather than $100. Thus, the regulation actually causes drug prices, in some cases, to be higher than otherwise. Although it could potentially increase costs to Medicaid, ending the regulation could make some drugs more affordable to some segments of the market, allowing lower prices for those who are less able to afford higher priced drugs.


We have outlined a few approaches that could make the pharmaceutical market better serve the needs of patients. In the United States, we have become so accustomed to the current level of FDA regulation that it is difficult to imagine reducing it. However, this is not an excuse for failing to think through alternative systems. The health, and pocketbooks, of patients demand that we do so. 



1.    DiMasi JA, Hansen RW, Grabowski HG. The price of innovation: new estimates of drug development costs. J Health Economics 2003; 22(2):151–185.

2.    Adams CP, Brantner VV. Estimating the cost of new drug development: is it really $802 million? Health Affairs 2006; 25(2): 420-428.

3.    DiMasi JA, Hansen RW, Grabowski HG. Briefing: cost of developing a new drug. Tufts Center for the Study of Drug Development.,_2014..pdf Published November 18, 2014. Accessed September 22, 2015.

4.     Klein DB. Drug-approval denationalization. Library of Economics and Liberty. Published April 6, 2009. Accessed September 22, 2015.

5.    US Food and Drug Administration. For Industry: Prescription Drug User Fee Act (PDUFA). Accessed September 29, 2015.

6.    Shughart WF II. Public Choice. in The Concise Encyclopedia of Economics. Henderson DR, ed. Indianapolis: Liberty Fund; 2008.

7.    Ventola CL. Off-Label Drug Information. Pharmacy Therapeut. 2009;34(8):428–440.

8.    Times Record News. Bill to let Medicare carry ‘off-label’ drugs. Published March 19, 2011. Accessed September 25, 2015.

9.    Mundy A, Dooren JC. Genentech fights the use of its own cheaper drug. The Wall Street Journal. Updated April 28, 2011. Accessed September 25, 2015.

10.    Dooren HC, Whalen J. Study compares Lucentis, Avastin. Updated April 28, 2011. Accessed September 25, 2015.

11.    US. Department of Veterans Affairs, Veterans Health Administration. CHAMPVA Policy Manual. Ch 2, Sect. 22.1 Pharmacy. Published December 23, 2011. Accessed September 25, 2015.

12.    American Cancer Society website. Off-label Drug Use: What is off-label drug use? Accessed September 28, 2015.

13.    National Institute of Diabetes and Digestive and Kidney Diseases. Gastroperesis. Update June 15, 2012. Accessed September 25, 2015.

14.    Rayner CK, Horowitz M. New management approaches for gastroparesis. Nat Clin Pract Gastroenterol Hepatol. 2005;2:454–462.

15.    Poole SG, Dooley MJ. Off-label prescribing in oncology. Support Care Cancer. 2004;12(5):302–305.

16.    Amyloidosis Foundation website. AL Amyloidosis. Accessed September 25, 2015.

17.    Rosen HS, Gayer T. Public Finance, 9th ed. p. 37. New York: McGraw-Hill/Irwin; 2010.

18. Medicaid Drug Rebate Program. Accessed September 29, 2015.