Elsevier

Journal of Public Economics

Volume 97, January 2013, Pages 327-336
Journal of Public Economics

Market size and innovation: Effects of Medicare Part D on pharmaceutical research and development

https://doi.org/10.1016/j.jpubeco.2012.10.003Get rights and content

Abstract

Recent evidence suggests that Medicare Part D increased prescription drug use among seniors, and increased pharmaceutical firms' revenues from sales. Previous studies also indicate that increases in market size induce pharmaceutical innovation. This paper assesses the impact of the Medicare Part D legislation on pharmaceutical research and development (R&D), using time-series data on the number of drugs entering preclinical and clinical development by therapeutic class and phase. We find that the passage and implementation of Medicare Part D is associated with significant increases in pharmaceutical R&D for therapeutic classes with higher Medicare market share.

Highlights

► Market expansion due to Medicare Part D could, in theory, induce innovation. ► We identify Part D's effect using variation in drugs' Medicare market shares. ► Preclinical and clinical testing significantly increased after Part D.

Introduction

Understanding the responsiveness of innovation to expected future revenues and market expansions is central to understanding the behavior of private sector innovative firms, and is also critical for evaluating the welfare effects of public policies such as insurance expansions, price controls, and patent protection. Although previous studies have shown that increases in market size are significant drivers of pharmaceutical innovation, magnitudes of the estimates of elasticity of innovation with respect to market size vary widely (Acemoglu and Linn, 2004, Dubois et al., 2011, Lakdawalla and Sood, 2012).

This paper builds on the existing literature on the impact of market size on innovation by analyzing the effects of one of the largest expansions of prescription drug insurance on pharmaceutical research and development (R&D). Specifically, we estimate the elasticity of drug R&D efforts—as measured by preclinical testing and clinical trials—following passage of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA), and evaluate changes over time in the magnitude of this investment response.

Prior to the MMA's implementation in 2006, with only a few exceptions1 the Medicare program covered only prescription medicines associated with physician services, i.e., drugs provided in physician offices and hospitals. Medicare Part D significantly expanded drug coverage among older individuals, and as of 2010 approximately 28 million Medicare beneficiaries were enrolled in Part D plans.2,3 Recent evidence indicates that this expanded insurance coverage increased prescription drug use by seniors (Duggan et al., 2008, Ketcham and Simon, 2008, Lichtenberg and Sun, 2007, Yin et al., 2008).

This increased use of prescription drugs due to expansion of insurance might be expected to yield increases in biopharmaceutical firms' R&D via two mechanisms. First, Scherer (2001) previously showed firms' R&D expenditures are approximately unit elastic with respect to increases in their revenues from sales. Duggan and Scott Morton (2010) showed that overall revenues for pharmaceutical firms increased upon implementation of Part D, despite the price decreases negotiated by private insurers. Thus, R&D might have increased after implementation of Part D simply due to established firms' increased cash flows.

Second, economic theory and prior studies also suggest that firms' investments in R&D should be responsive to changes in the expected profitability of candidate products in their pipelines. Consistent with this notion, Friedman (2009) observed immediate increases after passage of Part D in stock market share prices for firms launching brand-name drugs with high exposure to the Medicare market. These expectations of near-term and future revenues also likely contributed to the pharmaceutical industry's switch from opposition towards advocacy for Medicare outpatient prescription drug legislation in 1999:4

Successfully expanding prescription drug coverage for seniors and disabled persons will ensure that breakthroughs in basic scientific knowledge become safe and effective medicines for patients. If we fail, pharmaceutical innovation—especially with respect to medicines designed to treat the illnesses of aging—may suffer, thereby reducing hope for Medicare beneficiaries and their families. Modernizing Medicare is our best hope that today's and tomorrow's beneficiaries will reap the rewards of innovation: longer, happier, healthier, and more fulfilling lives. (Holmer, 1999)

In this paper, we identify the effects of Medicare Part D through variation across drug classes in their pre-Part D Medicare market shares, expecting larger increases in R&D for drug classes with higher pre-Part D Medicare market shares. We control for changes in demographics, as one would expect more R&D for higher-Medicare-share drug classes as the post-war Baby Boom population ages. We also control for changes in public expenditures on biomedical research, due to possible complementarities between public and private biomedical research efforts (Blume-Kohout, 2012).

To further isolate Part D's impact, in additional specifications we investigate heterogeneous effects using variation in drug classes' coverage status, such as whether the drug class was previously covered under Medicare Part B, whether it has “protected” status on plans' formularies, and whether the class is highly used by Medicare-Medicaid dual eligibles. We expect smaller effects for drugs previously covered by Medicare Part B because the MMA legislation decreased physician reimbursement for cancer chemotherapy drugs covered under Part B, and so neither expected utilization nor prices for those drugs should have increased with the MMA (Shea et al., 2008). In contrast, we expect larger Part D effects for protected drug classes, as the Centers for Medicare and Medicaid Services (CMS) require most marketed drugs in certain protected drug classes to be included on Part D plans' formularies, which precludes plans from using threat of exclusion to negotiate prices down. Similarly, we also expect larger Part D effects for drug classes heavily used by Medicare–Medicaid dual eligibles, as pharmaceutical firms are no longer required to offer steep Medicaid discounts for drugs sold to these consumers.

We find that the passage and implementation of Medicare Part D was associated with significant increases in preclinical testing and clinical trials for those drug classes most likely to be affected by Medicare Part D. These effects are robust to controls for expected demographic changes, and changes in public biomedical research funding. As expected, we also typically find smaller effects for drug classes previously covered by Medicare Part B, and larger effects for protected and dual eligible drug classes.

Our paper proceeds as follows. In the next section we describe the various datasets employed, and the construction of our panel dataset. In 3 Empirical approach, 4 Results, we present our empirical strategies, and summarize key results. The final section concludes, with a discussion of the implications and limitations of our analysis.

Section snippets

Data on pharmaceutical R&D pipelines

Time-series data on the number of drugs by therapeutic class and originator firm at each stage of the pharmaceutical R&D pipeline were derived from the Pharmaprojects trend data “snapshot” published each May from 1998 through 2010. Pharmaprojects data are collected from a variety of public sources including press releases, patent filings, conference proceedings, regulatory agencies' reports, and the medical literature, as well as through direct contacts with pharmaceutical companies and

Empirical approach

In the analyses that follow, our primary outcome variables are the number of drugs entering each R&D stage (Preclinical, Phase I, Phase II, and Phase III), for each therapeutic class and year. If pharmaceutical companies respond to the increases in market size as predicted, then all else equal we would expect to see an increase in the flow of drugs entering preclinical and clinical development. Table 1 below provides descriptive statistics for our outcome variables and our key explanatory

Results

In this section, we present regression results from panel count data estimation for drugs entering preclinical and clinical testing. We also compare results for drug trials in classes previously covered by Medicare Part B, and protected drug classes including those most used by Medicare–Medicaid dual eligible beneficiaries. Finally, we discuss results from our analysis of worldwide drug launches and firms' R&D expenditures, which support the trends we observe in firms' R&D efforts.

Discussion

Our results indicate that the increase in outpatient prescription drug coverage provided through Medicare Part D has had a significant impact on pharmaceutical R&D. We observe evidence of a structural break in established R&D trends after passage and implementation of Part D, with greater percentage increases in drug trials for therapeutic classes that are most used by Medicare beneficiaries. In addition, we find stronger effects of Part D for protected classes, which, following Duggan and

Role of funding sources

This work was supported in part by the Roybal Center for Health Policy Simulation, funded by the National Institute on Aging grant 5P30AG024968. N. Sood also acknowledges support from the National Institute on Aging grant P01AG033559. M. Blume-Kohout likewise gratefully acknowledges partial financial support from the Ewing Marion Kauffman Foundation. Finally, we thank Pfizer Inc. for providing access to the Pharmaprojects database. These sponsors have had no role in our study design, analysis,

Acknowledgments

We thank Darius Lakdawalla, Dana Goldman, Greg Ridgeway, Sean Nicholson, Matthew Rutledge, Mark Duggan, two anonymous reviewers, and seminar participants at RAND, UCLA, and the University of Waterloo for their helpful comments on this work.

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