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Chapter 6 National Support for Emerging Industries The appropriate role of public policy in promoting specific industries has been a source of passionate debate in the United States since the founding of the Republic.1 Many nations in Europe and Asia have not hesitated to use the full force of government to attain commercial competitive advantage in industries they regarded as strategic. In the United States, however, the idea of proactive government help for private industry in the name of economic development has sometimes raised concerns about distorting market forces and the wisdom of letting public servants “pick winners.” The debate began with Alexander Hamilton, who was an early advocate of “bounties” to encourage desirable industry, continued through the 19th century, and has resurfaced many times in the post-war era as U.S. industry confronted new competitive challenges. These policy debates have to some extent obscured actual practice, both in the United States and abroad. In reality, the U.S. federal government has played an integral role in the early development of numerous strategic industries, not only by funding research and development but also through financial support for new companies and government procurement. Telecommunications, aerospace, semiconductors, computers, pharmaceuticals, and nuclear power are among the many industries that were launched and nurtured with federal support. The intensifying global race to dominate an array of emerging high- tech industries once again has focused attention on the role of public policy. As China, South Korea, Germany, and Taiwan target industries such as renewable energy equipment, solid-state lighting, electric vehicles, and next-generation 1 The link between national security and the need to develop key domestic industries was identified by Adam Smith, a contemporary of Hamilton, who noted that “if any particular manufacture was necessary, indeed, for the defense of the society it might not always be prudent to depend upon our neighbors for the supply.” Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776. 321
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322 RISING TO THE CHALLENGE displays with comprehensive strategies and generous subsidies, the U.S. has struggled to compete. The financial crisis of 2008 has made it even more difficult for U.S. technology companies to raise the capital needed to turn designs into prototypes and prototypes into products made in large volumes. In recent years, the Science, Technology, and Economic Policy Board of the National Academies has extensively studied the competitive challenges facing a number of important high-tech industries. The STEP board also has studied the policies adopted other nations and compared them to those of the United States. This chapter explores the major policy issues in four of these industries—semiconductors, photovoltaic products, advanced batteries, and pharmaceuticals. Each of these industries can be regarded as strategic to the United States. Integrated circuits are the building blocks of all electronics products and have enabled the breathtaking advances in information technology that drive productivity gains across all industries. American leadership in semiconductors also is vital to the technological superiority of the U.S. military. Photovoltaic cells are the enabling technology of solar power, a key source of renewable energy that can serve America’s national interests in reducing dependence on petroleum and cutting greenhouse gas emissions. Advanced batteries and their electrical management systems are the core components of hybrid and electric vehicles, much as internal combustion engines have been to conventional gasoline-powered cars and trucks. A strong domestic battery industry, therefore, is regarded as crucial to the future competitiveness of the U.S. auto industry. Lightweight, long-lasting, rechargeable energy-storage systems also are required for advanced weapons systems being developed by the U.S. military and for storing renewable energy for utility power grids. The pharmaceuticals industry is likewise strategic, producing medicines and vaccines that are essential to the well-being of Americans and indeed the world’s people. U.S. leadership in this sector has been secured through enormous federal investments, though the industry faces numerous challenges in terms of litigation, regulatory pressure, and counterfeit drugs. Each of these three industries shares another characteristic. The core technologies are the fruits of decades of research at U.S. universities and national laboratories at considerable American taxpayer expense. Many of the early U.S. companies that pioneered these industries, moreover, were supported over the years through federal research grants, small-business loans, and government and military procurement. As they reached the point of large-scale commercial production, each of these U.S. industries encountered severe global competitive challenges2. Concerted Japanese government policies to facilitate joint R&D, transfer 2 See Glenn Fong, “Breaking New Ground, Breaking the Rules—Strategic Reorientation in U.S. Industrial Policy,” International Security 25:2 pp 152ff.
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NATIONAL SUPPORT FOR EMERGING INDUSTRIES 323 commercial technology to companies, protect domestic producers from imports helped Japanese companies in the 1970s and 1980s seize a commanding global market share in dynamic random-access memory chips, sending the U.S. semiconductor industry into crisis. U.S. companies dominated the nascent photovoltaic industry through the 1980s. Leadership in mass production of cells and modules, however, was assumed by Japan in the 1990s—and then Germany, Taiwan, and China—after each of these nations or regions enacted policies to build domestic markets for solar power or to promote manufacturing. The lithium-ion industry is one of several high-tech sectors that grew from U.S.- invented technology but was never industrialized domestically. Instead, Japanese companies were the first to mass-produce rechargeable lithium-ion batteries for electronic devices and notebook computers because of their large- scale production of consumer electronics. South Korean and Chinese manufacturers followed their lead. Asian producers, therefore, have a huge advantage in the small but extremely promising market for rechargeable batteries for cars and trucks. The four industries illustrate different aspects of the public policy debate. The U.S. semiconductor industry is a case study in how a strategic sector that had lost competitive advantage in production and a once-dominant market share was able to regain global leadership through cooperation on pre- competitive R&D and public policy initiatives with responsive government actions. The public-private research consortium SEMATECH and assertive U.S. trade policies in response to Japanese dumping and protectionism enabled the industry rebound. The photovoltaic industry is an example of a U.S. high-tech sector that has lost global share but has a solid opportunity to re-emerge as a leader with the right mix of federal and state policy support. In the case of solar power, a deciding factor will be whether the United States will become a big enough market to support a large-scale, globally competitive manufacturing industry. Federal and state incentives will be essential for the next few years, until the cost of solar energy can compete against electricity generated from fossil fuels without subsidies. Another question is whether U.S. companies that focus on products incorporating promising new technologies will be able to survive surging imports of low-cost photovoltaic cells and modules based on mature technologies long enough to attain economies of scale. What’s more, because technologies are still evolving rapidly, and there are not yet commonly accepted manufacturing standards, the global race for future leadership remains wide open. Public-private research partnerships will be essential to ensure that the U.S. can be a leader in the race for global market share. The emerging U.S. advanced battery industry represents a bold experiment by the federal government in direct financial support of private companies to establish a domestic manufacturing industry. Prior to 2008, the
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324 RISING TO THE CHALLENGE U.S. had a number of lithium-ion battery start-ups but virtually no production plants.3 It now has dozens of battery-related factories that are beginning to ramp- up, thanks in part to $2.4 billion in grants and support under the American Recovery and Reinvestment Act. Like photovoltaic cells, however, prices of lithium-ion auto batteries are too high, making hybrid and electric vehicles expensive for most consumers compared to conventional gasoline-powered vehicles. Larger demand, in turn, is required for the industry to attain the economies of scale that will bring prices down, in turn generating higher demand. In addition, further innovation is required to improve battery performance and reduce cost. Federal policies to support expansion of the market and public-private R&D collaboration will likely be required for the foreseeable future, but the long-term gain to the economy and national security can be significant. The ascent of the U.S. pharmaceutical industry has been driven by massive federal support for life sciences R&D, primarily by the National Institutes of Health (NIH). During the decade of 2001, U.S. firms developed 57 "new chemical entities" (NCEs) compared with 33 by European firms and nine by Japanese firms, erasing the European lead which existed in prior decades. Despite the spectacular successes of past two decades, the U.S. pharmaceutical industry's future prospects are uncertain. Many of the blockbuster drugs that drove the industry's success have gone off patent or will do so soon, including first-generation biotechnology drugs, and branded producers face growing competitive pressure from generic drug makers. The costs and risks of developing new drugs and bringing them to market are rising, while the productivity of the industry's R&D appears to be declining. In light of key developments, especially in emerging markets, a key challenge is to sustain the productivity and competitiveness of this strategic U.S. industry. SEMICONDUCTORS A little more than two decades ago, the U.S. semiconductor industry appeared to be going the way of the U.S. consumer electronics industry. Japanese companies had seized a commanding world market share and technological lead in memory devices and were rapidly adding more production capacity. Struggling U.S. chipmakers were abandoning a large segment of the industry that made memory products, an essential part of computers and other leading semiconductor technologies of the eighties. There was widespread concern that erosion of America’s semiconductor industry posed not only economic challenges, but national security risks as well. Even after the U.S. government had begun to mount a strong policy response to bolster U.S. 3 “In 2009, the U.S. made less than 2 percent of the world’s lithium-ion batteries.” Jon Gertner, “Does America Need Manufacturing?” The New York Times, August 24, 2011.
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NATIONAL SUPPORT FOR EMERGING INDUSTRIES 325 competitiveness, a defense task force warned in 1987 that a dependence on foreign suppliers for state-of-the-art chips for weapons was an “unacceptable situation” because it would undermine the U.S. military strategy of maintaining technological superiority.4 This national security concern and the willingness of the semiconductor industry to collectively seek policy help from Washington were instrumental in reversing the loss of market share and technology lead that seemed irretrievably lost. Remarkably, as recounted below, the U.S. semiconductor regained global leadership by the early -1990s and —despite the dramatic rise of new competitors in South Korea, Taiwan, and China—remains today a top semiconductor producer. Even though the U.S. market accounts for only 18 percent of the global sales for integrated circuits, sales by U.S. companies accounted for 48 percent of the world market in 2010.5 [See Figure 6.1] While only one U.S. company is still a major player in memory chips, the U.S. semiconductor industry dominates the lucrative market for logic devices such as microprocessors and analog mixed signal products.6 Moreover, despite rapid growth in outsourcing to Asian foundries (wafer fabrication factories that produce integrated circuits on a contract basis for other firms), the vast majority of production and R&D by U.S. semiconductor companies remains in the United States.7 Seventy-seven percent of capacity owned by America semiconductor companies is located in U.S. and 74 percent of compensation and benefits is paid to U.S.-based workers.8 And while the vast majority of chip companies now outsource fabrication of the devices they design to foundries located in Asia, approximately 500 of the world’s 1,200 so-called “fabless” design firms—including most of the industry leaders—are headquartered in North America.9 4 See U.S. Department of Defense, Report on Semiconductor Dependency, Office of the Undersecretary of Defense for Acquisition, prepared by the Defense Science Board Task Force, Washington, DC, February 1987. 5 Source: Semiconductor Industry Association citing data from based on World Semiconductor Trade Statistics data. 6 Micron Technologies, headquartered in Boise, Idaho, is the leading U.S. producer of computer memory chips. 7 For an analysis of semiconductor R&D has remained in the U.S. despite outsourcing of production, see Jeffrey T. Macher, David C. Mowery, and Alberto Di Minin, “Semiconductors,” chapter 3 in National Research Council, Innovation in Global Industries: U.S. Firms Competing in a New World, Jeffrey T. Macher and David C. Mowery, eds., Washington, DC: The National Academies Press, 2008. 8 Semiconductor Industry Association (SIA), Maintaining America’s Competitive Edge: Government Policies Affecting Semiconductor Industry R&D and Manufacturing Activity, March 2009. This report can be accessed at http://www.sia-online.org/galleries/default- file/Competitiveness_White_Paper.pdf. 9 Global Semiconductor Alliance, Industry Data at http://www.gsaglobal.org/resources/industrydata/facts.asp. The largest fabless companies include QUALCOMM, Broadcom, AMD, NVIDIA, and LSI.
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326 RISING TO THE CHALLENGE 70 Share of Global Semiconductor Sales (Percent) 60 50 40 30 20 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 FIGURE 6.1 Global market share of U.S. semiconductor companies, 1982- 2010. SOURCE: Semiconductor Industry Association. NOTE: Share data based on nationality of company. This turn of fortunes is primarily due to strategic moves and investments in new technologies by U.S. semiconductor manufacturers. Yet, their success also rests on the important contributions of U.S. policy that was driven by an engaged industry. There were two additional interrelated elements to the U.S. success:10 The research consortium SEMATECH, a $200 million-a- year research effort co-funded by the federal government and most large American chip companies, accelerated productivity and innovation in semiconductor manufacturing based on a common technology roadmap and 10 The recovery of the U.S. industry has been described as a three-legged stool. It is unlikely that any one factor would have proved sufficient independently. Trade policy, no matter how innovative, could not have met the requirement to improve U.S. product quality. On the other hand, by their long-term nature, even effective industry-government partnerships can be rendered useless in a market unprotected against dumping. Most importantly, neither trade nor technology policy can succeed in the absence of adaptable, adequately capitalized, effectively managed, technologically innovative companies.
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NATIONAL SUPPORT FOR EMERGING INDUSTRIES 327 enabled a rapid decline in prices.11 Persistent trade negotiations and enforcement of previous agreements won commitments from Japan to open its market to U.S. semiconductors and curtail dumping in any world market.12 This was deemed essential to prevent the United States from becoming a high- priced island in a sea of underpriced semiconductors. Had that occurred, it would have severely disadvantaged downstream American electronics equipment producers compared with competitors producing abroad utilizing lower-priced dumped chips.13 The decline and resurgence of the U.S. semiconductor industry offers many useful lessons for policymakers and industrialists grappling with how to bolster other American high-technology sectors facing intense international competitive pressure. It shows that erosion of U.S. leadership in manufacturing is not irreversible as long as both industry and government are committed to cooperative action, both on trade policy and in well-designed research programs that will lead to innovation. In a comprehensive analysis of the semiconductor experience, the National Research Council concluded that overcoming competitive challenges requires “continued policy engagement and public investment through renewed attention to basic research and cooperative mechanisms such as public-private partnerships.”14 11 For analysis of the contributions of SEMATECH, see presentation by Kenneth Flamm of the University of Texas in National Research Council, Innovative Flanders: Innovation Policies for the 21st Century—Report of a Symposium, Charles W. Wessner, editor, Washington, DC: The National Academies Press, 2008. For a more extensive treatment, see Kenneth Flamm, “SEMATECH Revisited: Assessing Consortium Impacts on Semiconductor Industry R&D,” in National Research Council, Securing the Future, O P. CIT. See also, Peter Grindley, David C. Mowery and Brian Silverman. “SEMATECH and Collaborative Research: Lessons in the Design of High Technology Consortia, Journal of Policy Analysis and Management, 13(4) 1994, pp. 723-758. 12 In the U.S.-Japan Semiconductor Trade Agreement, signed on Sept. 2, 1986, Japan agreed to eliminate dumping of semiconductors following a U.S. Department of Commerce finding that Japanese producers sold memory chips in the U.S. at below the cost of production. Japan also agreed to open its market to foreign-made chips and to cease dumping in any market. In 1990, Japan signed a second bilateral trade agreement that provided U.S. producers with a “fast-track” process for addressing dumping allegations and promised to fulfill an earlier pledge that foreign producers achieve a minimum 20 percent share of the Japanese semiconductor market. This figure was chosen because it would give foreign producers access to the customer base of the six giant vertically integrated Japanese companies that controlled the Japanese market. The trade agreement was remarkable in that it did not close the U.S. market, but instead opened the previously closed Japanese markets and stopped dumping in third markets. 13 For a full description of the how Japan closed its market for all foreign semiconductor producers, see Thomas R. Howell, William A. Noellert, Janet H. McLaughlin, and Alan Wm. Wolff, The Microelectronics Race, Boulder, Colo., and London: Westview Press, 1988. 14 National Research Council, Securing the Future: Regional and National Programs to Support the Semiconductor Industry, Charles W. Wessner, editor, Washington, DC: The National Academies Press, 2003.
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328 RISING TO THE CHALLENGE The Strategic Importance of Semiconductors The importance of semiconductors to the United States is difficult to overstate. As an industry, the semiconductor sector directly employs over 180,000 Americans and has consistently ranked as either America’s No. 1 or No. 2 export industry.15 Semiconductors represent the core technology of the modern electronics revolution, enabling products from smart phones and computers to advanced weapons systems. More importantly, semiconductors have made possible the rapid advances in information technology that drive productivity gains across other industries. As one National Academies study noted— “...often called the ‘crude oil of the information age,’ semiconductors are the basic building blocks of many electronics industries. Declines in the price/performance ratio of semiconductor components have propelled their adoption in an ever-expanding array of applications and have supported the rapid diffusion of products utilizing them. Semiconductors have accelerated the development and productivity of industries as diverse as telecommunications, automobiles, and military systems. Semiconductor technology has increased the variety of products offered in industries such as consumer electronics, personal communications, and home appliances.”16 The impact of semiconductor-based information technology has been so pervasive that many economists regard it as the catalyst behind the acceleration in productivity growth in the U.S. economy since the mid-1990s.17 Meeting critical national needs such as increased energy efficiency, lower-cost and improved health care services, and ubiquitous access to high-speed broadband data communications will depend on further advances in 15 Patrick Wilson, Director of Government Affairs, Semiconductor Industry Association, “Maintaining US Leadership in Semiconductors,” AAAS Annual Meeting, February 18, 2011. 16 This excerpt is taken from Jeffrey T. Macher, David C. Mowery, and David A. Hodges, “Semiconductors,” U.S. Industry in 2000: Studies in Competitive Performance, David C. Mowery, ed., Washington, DC: National Academy Press, 1999, p. 245. 17 For an analysis of the role of new information technologies in recent high productivity growth, often described as the New Economy, see Dale W. Jorgenson, “The Emergence of the New Economy” in Enhancing Productivity Growth in the Information Age, Dale W. Jorgenson and Charles W. Wessner, eds., Washington, DC: National Academy Press, 2007. Also see National Research Council, Measuring and Sustaining the New Economy, Report of a Workshop, D. Jorgenson and C. Wessner, eds., Washington, DC: National Academy Press, 2003, and Council of Economic Advisers, Economic Report of the President, H.Doc.107-2, Washington, DC: USGPO, January 2001.
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NATIONAL SUPPORT FOR EMERGING INDUSTRIES 329 semiconductors.18 Semiconductors also remain vital to national security, observes the Industrial College of the Armed Forces, because “they are the building blocks of the nation’s infrastructure and the space, communications, and weapons systems that allow the projection of American diplomatic, information, military, and economic power.”19 A New Set of Challenges Continued American leadership in semiconductors certainly cannot be taken for granted, however. The industry faces a range of technological, financial, and competitive challenges. Among the most prominent— • Declining share of capacity: U.S. semiconductor companies still invest billions of dollars in wafer fabrication facilities in the United States. But investment by manufacturers in Asia is expanding faster. The share of global installed wafer fabrication capacity in the United States declined from 42 percent in 1980 to about 16 percent in 2007.20 American semiconductor companies are investing a proportionately larger share of their total worldwide fabrication capacity spending outside of the United States. The share of spending in the United States for wafer manufacturing capacity has dropped by 14.6 percentage points between 1997-1999 and 2005-2007, from 78.5 percent to 63.9 percent.21 The Semiconductor Industry Association (SIA) expects the U.S. share to decline by another 9.3 percentage points by 2013.22 What’s more, only 14 percent of leading-edge capacity (300 mm wafers) is located in the United States. The largest market for state-of- the-art manufacturing equipment is in Asia, principally South Korea, Taiwan and Japan.23 • Business and capital costs: As the cost of building new leading-edge wafer fabrication plants reach some $4 to $6 billion, factors such as tax rates and government incentives now heavily influence corporate 18 The RAND Corporation, for example, estimates that application of information technology in the health care sector could result in annual efficiency savings of $77 billion. See RAND Corporation, Health Information Technology: Can HIT Lower Costs and Improve Quality?, 2005, (http://www.rand.org/pubs/research_briefs/RB9136/index1.html). Also see Jorgenson, “The Emergence of the New Economy,” op. cit. 19 Industrial College of the Armed Forces, Electronics 2010, Industry Study Final Report, National Defense University, Spring 2010, (http://www.ndu.edu/icaf/programs/academic/industry/reports/2010/pdf/icaf-is-report-electronics- 2010.pdf). 20 SIA, Maintaining America’s Competitive Edge, op cit. 21 Ibid. 22 Ibid. 23 SEMI Industry Research and Statistics Group data.
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330 RISING TO THE CHALLENGE decisions on where to build capacity. Countries such as Malaysia, India, Singapore, China, and Israel and regions such as Taiwan offer tax holidays or significantly reduced rates. Germany offers grants and loans to chip manufacturers. Federal and state tax breaks and other benefits offered in the U.S. are often either insignificant or non- competitive,24 according to the SIA. • Talent: The American semiconductor industry is becoming increasingly dependent on foreign-born R&D staff at a time when immigration rules have tightened and opportunities abroad are growing. More than 50 percent of students graduating from U.S. universities with master’s degrees and 70 percent of doctorates in science and engineering disciplines applicable to semiconductors are foreign nationals.25 Meanwhile, nations and regions such as India, China, and Taiwan are rapidly increasing their supply of semiconductor engineers. An inability of industry to hire top talent in the U.S. could lead to a greater shift of R&D offshore. • Offshore R&D: Even though U.S. semiconductor companies conduct most of their R&D onshore, that proportion has declined by 8.4 percent points from 1997-1999 to the 2005-2007 period. Most of the work is going to Europe, Israel, and Singapore, and increasingly to Romania. Meanwhile, the outsourcing by American companies of chip fabrication to Asian foundries—plants that fabricate chips on a contract basis— means that semiconductor design can go to any place that has the best supply of engineers.26 • Competing Consortia: While federally funded U.S. research is under budget pressure, other nations have learned from the accomplishments of SEMATECH and have formed their own public-private partnerships aimed at becoming the first to commercialize next-generation semiconductor technologies. At the same time, the ability to continue improving the performance of integrated circuits along the path predicted by Moore’s Law27 through current transistor technology may be nearing its physical limits.28 The U.S. faces growing competition to develop technologies to replace silicon-based, CMOS semiconductors, 24 The U.S. currently offers a 9 percent manufacturing tax credit and a temporary R&D tax credit, although states such as New York offer sizeable incentives. 25 SIA, Maintaining America’s Competitive Edge, op cit. 26 Ibid. 27 Moore’s Law is based on the prediction by Intel co-founder Gordon Moore in 1965 that the number of transistors that can be placed inexpensively on an integrated circuit doubles every two years. 28 One recent development that could alter this view is Intel Corp.’s recent announcement that it had successfully demonstrated the world’s first 3-D transistor, called Tri-Gate, used in a 22nm microprocessor. Intel claimed its technology will “advance Moore’s Law into new realms.”
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NATIONAL SUPPORT FOR EMERGING INDUSTRIES 331 a challenge that Nanotechnology Research Institute Director Jeffrey Welser says is as dramatic as the replacement of vacuum tubes by semiconductors in the 1940s.29 These challenges must be addressed. “At some point,” the SIA warns, “without sufficient U.S. government support of basic R&D and supportive tax, immigration, and education policies, it may well prove to be very difficult if not impossible to reverse current trends.”30 Industry Growth and U.S. Policy The federal government was at the outset deeply involved in the U.S. semiconductor industry. Indeed, as economist Laura Tyson observed in 1992: “The semiconductor industry has never been free of the visible hand of government intervention.”31 The U.S. Signal Corps was the prime funder of the R&D that led to development of the transistor and semiconductors for three decades and purchased most of the initial output. The military funded the first pilot production lines of Western Electric, General Electric, Raytheon, and Sylvania and construction of production capacity far in excess of demand. From the late 1950s through the early 1970s, the federal government funded between 40 to 45 percent of U.S. R&D in semiconductors.32 Military purchases of semiconductors enabled the industry to establish the scale that led to a dramatic drop in prices between 1962 and 1968,33 making them more practical for commercial use. Japan’s entry into the dynamic random-access memory (DRAM) industry, backed by low-cost capital and a protected home market, resulted in dramatic increases in capacity and dumping of product on third-country markets. Some U.S. companies also lagged the Japanese competition in quality and productivity using the same equipment sets. The result was a reduction of the U.S. global share in this market from around 90 percent to less than 10 percent by 1985, and producers such as Intel, Advanced Micro Devices, and National 29 Testimony by Jeffrey Welser, Nanoelectronics Research Initiative director, before the House Committee on Science, Space, and Technology’s Subcommittee on Research and Science Education, April 14, 2011, http://science.house.gov/sites/republicans.science.house.gov/files/documents/hearings/Welser%20Te stimony%20FINAL.pdf). 30 SIA, Maintaining America’s Competitive Edge, op. cit. 31 Laura D’Andrea Tyson, Who’s Bashing Whom? Trade Conflict in High Technology Industries, Washington, DC: Institute for International Economics, 1992. 32 A concise history of U.S. government involvement in establishment of America’s electronics industry is found in Kenneth Flamm, Mismanaged Trade?: Strategic Policy and the Semiconductor Industry, Washington, DC, Brookings Institution, 1996. pp. 27-38. 33 Defense Science Board, “High Performance Microchip Supply,” 2005.
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420 RISING TO THE CHALLENGE involves complex matters that the committee has not had an opportunity to examine in detail. Stock prices of life sciences firms are frequently volatile and can be affected by disclosure (whether or not authorized) of the results of clinical trials and FDA proceedings associated with approval of a promising new drug. Allegedly misleading disclosure or nondisclosure of problems can result in volatility in the share prices of a company's stock. The collapse of share prices under such circumstances commonly gives rise to costly class action lawsuits.447 Companies may also face enforcement proceedings by the Securities and Exchange Commission.448 Compulsory Licensing. Pharmaceutical companies with proprietary drugs are under price pressure from many governments outside the United States, and one powerful legal tool that is sometimes utilized is the compulsory licensing of patented drugs.449 The World Trade Organization (WTO) Agreement on the Trade-Related Aspects of Intellectual Property Rights (TRIPS) permits governments under certain conditions to compel a patent holder to allow the subject of the patent to be used by others.450 This clause has been invoked by several countries.451 A number of governments have used a threat of 447 The experience of Sequenom illustrates this phenomenon. In June 2008, Sequenom disclosed that a non-invasive prenatal test which it had developed to screen maternal blood for Downs syndrome was effective in all samples, sending its shares up 21.8 percent on eight times average volume. However, on the eve of the product launch, Sequenom revealed that the introduction of the test would be delayed "due to the discovery by company officials of employee mishandling of R&D test data and results," and that the company's board had launched an independent internal investigation. The special committee charged with conducting the investigation concluded that Sequenom "failed to provide adequate protocols and controls" of results of the prenatal test. The company's CFO and other executives resigned. The company fired its CEO and head of research and development. Share prices collapsed, and numerous class action suits were brought on behalf of shareholders who bought Sequnom shares after the 2008 disclosure of a promising new drug. The complaints alleged that the company made "materially false and misleading statements regarding the clinical performance of the Company's developmental Down syndrome test." "Sequenom Announces Additional Positive Tests Results for Down Syndrome Test at Analyst Briefing. "Chemical Business NewsBase (September 23, 2008); "Sequenom Raises Bar in Prenatal Test Field," Investor's Business Daily (December 16, 2008); "Sequenom Readies Tests for Market," Business Review Western Michigan (March 26, 2009); "Sequenom Announces Delay in Launch of SEQureDx Trisomy 21 Test," Business Wire (April 29, 2009); "Sequenom: Bloodied and Unbowed," Barron's (September 29, 2009). 448 In 2008, the SEC filed a civil fraud action against Biopure Corporation, alleging that the company materially misled the investment community by failing to disclose — or by framing as positive developments — certain negative information from the FDA regarding the approval prospects of its synthetic blood product, Hemopure." "Increased Scrutiny of Investor Communications by Federla Regulators," Food and Drug Law Institute (January/February 2006). 449 "Big Pharma Learns to Live With Generics," Bangkok Post (August 15, 2009). 450 Compulsory licensing can be used in "a national emergency as other circumstances of extreme urgency." TRIPS Article 31. 451 In 2007, Brazil issued a compulsory license for Merck's anti-AIDS drug Efavirenz. In 2006, Thailand issued compulsory license for two anti-AIDS drugs made by Merck and Abbott Laboratories, and a compulsory license for the anti-cancer drug Docetaxel, patented by the French
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NATIONAL SUPPORT FOR EMERGING INDUSTRIES 421 TABLE 6.5 Shareholder Class Action Lawsuits Against Life Sciences Firms Year Defendant Product Allegation 2009 Pozen Inc Treximet False or misleading statements about migraine drug candidate, Treximet 2009 Caraco Pharmaceutical various tablets Failure to disclose Laboratories material information re FDA warning letter on drug manufacturing. 2009 Rigel Pharmaceuticals R788 False and misleading statements with respect to clinical trial of a drug, R788 for treatment of rheumatoid arthritis 2008 KV Pharmaceutical Co Makena Failure to disclosure compliance problems with FDA requirements 2009 Immucor Blood reagents Failure to disclose and related compliance problems with equipment FDA requirements SOURCE: Brian Johnson et al v. Pozen Inc. et al, U.S. District Court, Middle District of North Carolina (2009)l ; Wilkof v. Caraco Pharmaceutical Laboratories, Ltd., U.S. District Court, Eastern District of Michigan (2009); Immucor, Inc. Form 10-K for the fiscal year ended May 31, 2011, p. 16; “KV Pharmaceutical Company Hit by Investor Class Action Over Alleged Securities Law Violations, “ Shareholders Foundation (October 19, 2011). compulsory licensing to pressure foreign pharmaceutical firms into reducing drug prices.452 TRIPS requires that compulsory license "shall be authorized predominantly for the supply of the domestic market," but in 2009 the WTO firm Sanofi-Aventis. "Compulsory Thai Licensing of AIDS Drug Sets Precedent," Deutsche Press Agentur (July 29, 2008); "Commerce Ministry Asks Council of State for Opinion on Legality of Compulsory Licensing of Cancer Drug," Thai Press Reports (August 22, 2008). 452 In 2009, Korea threatened Roche with compulsory licensing in negotiations over the supply of Tamiflu to Korea. The government of Brazil has applied similar pressure to multinational drug makers, particularly with respect to the supply of anti-retroviral drugs to treat HIV/AIDS. "Tamiflu Generics Protection Planned," Korea Times (September 9, 2009); "GSK and Fiocruz to Develop and Product Vaccines," Economist Intelligence Unit (September 14, 2009).
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422 RISING TO THE CHALLENGE ruled that Pakistan could grant compulsory licenses on patented drugs for export to third countries that lacked their own manufacturing capacity.453 In March 2012, the Controller of Patents, Mumbai, granted Natco Pharma, an Indian company, a compulsory license for manufacture of a generic version of sorafenib toyslate, a drug developed by Bayer to treat liver and kidney cancer, stating that the drug was "exorbitantly priced."454 Supply chain vulnerabilities. Governments in western countries are pressing pharmaceutical firms to reduce the cost of their products, and one way in which the industry is responding is to move the manufacture of drugs to lower cost countries and to source ingredients from those countries. Roughly 80 percent of the active ingredients used in U.S. prescription drugs originate outside the U.S.455 “[W]hether locally made generics, or patented drugs produced by either a multinational or a contract-manufacturing organization, Chinese-made prescription drugs will soon become unavoidable.” Imports from China and India accounted for about 20 percent of the generic and over-the- counter drugs sold in the U.S. in 2008.456 A number of scandals have occurred in which U.S. consumers have been harmed through use of drugs with adulterated ingredients derived from unregulated or under-regulated companies in China.457 Recently the Chinese government has taken steps to strengthen supervision of companies which comprise the pharmaceutical supply chain, but a recent incident in which large numbers of commonly used capsule drugs were found to contain high levels of toxic chromium indicates that significant risks still exist.458 453 "WTO Allows Pakistan to Grant License," Business Recorder (October 3, 2009). 454 "India Uses Arm-Twist Rule for Cancer Drug," The Telegraph Online (March 13, 2012). 455 “Counterfeit Avastin Seized in the US,” Pharma Times (February 16, 2012). 456 “Clamping Down on Fakes,” Chemical Business NewsBase (September 8, 2008). 457 “Chinese Chemicals Flow Unchecked Onto World Drug Market,:” The New York Times (October 31, 2007). In 2008 Baxter International suspended sales of the anti-coagulant heparin produced at an uncertified plant in China which was not inspected by the government after four U.S. users died and 350 suffered complications. “China Didn’t Check Drug Suppliers, Files Show,” The New York Times (February 16, 2008). “Will US Inspections Help Improve the Safety of Chinese Drugs?” Economist Intelligence Unit (April 15, 2008). 458 The capsules were made of industrial gelatin, and the chromium could cause digestive disorders and internal organ failure. An advisory expert at the State Food and Drug Administration commented that "drug quality control has been quite strict on end products. We examine all the quantities and qualities of medical substances inside the capsules. But somehow we have left out instrumental materials like the capsules themselves. That's a loophole, and we certainly need to address it." The government shut down two of the capsule plants and took four plant owners into police custody. "Capsule Scandal Exposes Loopholes in Drug Quality Control," China Radio International Online (April 17, 2012). In China, Good Manufacturing Practices (GMP) standards were introduced in the late 1970s but were phased in very slowly. The State Food and Drug Administration (SFDA) issued revised GMP standards in 1999, requiring all pharmaceutical manufacturers to meet GMP standards and secure GMP certification by June 30, 2004. New and more stringent GMP rules governing pharmaceutical production took effect October 1, 2010, requiring producers to apply for supplementary registration if the new standards were not met.
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NATIONAL SUPPORT FOR EMERGING INDUSTRIES 423 Supply chain vulnerabilities arise out of the increasing use of lower- cost bulk active pharmaceutical ingredients (APIs) as ingredients in manufactured drugs. In some major countries makers of APIs can sidestep regulatory scrutiny by not disclosing that their chemicals will be used in pharmaceutical products.459 Bulk APIs are now sold over the Internet, which is also a global platform for marketing and sale of counterfeit drugs. Some contaminated substances find their way into the U.S. healthcare system.460 Counterfeiting and mislabeling. Counterfeit and mislabeled medicines are a growing global concern both for legitimate pharmaceutical manufacturers and consumers. According to the World Health Organization, fake drugs account for under one percent in developed countries but from 10 to 30 percent of drug sales in emerging markets.461 Counterfeit medicines “are often produced in unsanitary conditions by people without any medical or scientific background.”462 Spuriously/falsely-labeled/falsified/counterfeit (SFFC) medicines can result in treatment failure and death. In 2012 the FDA sent out letters to 19 medical practices warning that counterfeit versions of Avastin, made by Roche and Greentech, had been detected in the U.S. and “may have left patients without their therapy.”463 The World Health Organization cites a number of other examples of known SFFC incidents. Counterfeit drugs increase the business risks of legitimate pharmaceutical manufacturers. Branded firms may find themselves targeted by lawsuits based on consumer use of worthless or toxic counterfeit medicine bearing the company’s brand. U.S. and European pharmaceutical firms which have Chinese operations or incorporate Chinese APIs in their manufacturing processes risk legal actions by consumers. Historically legitimate Many Chinese manufacturers are finding compliance with GMP standards to be financially burdensome. Some companies reportedly received GMP certification despite their deviation from GMP requirements, and “one factor causing this poor state of GMP implementation is believed to be a lack of transparency in the drug administration system” (Royan Gai, et al, “GMP Implementation in China: A Double-Edged Sword for the Pharmaceutical Industry”, Drug Discoveries and Therapeutics (January 2007)) 459 Chinese regulators do not supervise the production of raw materials used in pharmaceutical manufacture, so-called “intermediates” which are used to make APIs. The lack of oversight has contributed to tragedies such as the death and disability of 128 Panamanians who used cold medicine manufactured in China which contained diethylene glycol, a toxic substance normally used as engine coolant but sometimes utilized as a substitute for glycerine. “Chemicals Flow Unchecked from China to Drug Market,” Kyodo (November 1, 2007). 460 In 2007 University Health Care System, based in Augusta, Georgia was warned by one of its suppliers that some of the oral care kits used by the hospital might contain toothpaste made in China containing toxic diethylene glycol. “This Problem Made in China,” Modern Healthcare (October 22, 2007). 461 “Just How Big is the Counterfeit-Drug Problem?” FiercePharma (September 13, 2010). 462 “Pfizer Steps Up Campaign in Fight Against Counterfeit Drugs,” Pharma Times (September 30, 2011). 463 “Counterfeit Avastin Seized in the US,” Pharma Times (February 6, 2012).
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424 RISING TO THE CHALLENGE TABLE 6.6 Examples of SFFC Medicines SFFC medicine Country/Year Report Anti-diabetic traditional China, 2009 Contained six times the medicine (used to lower normal dose of blood sugar) glibenclamide (two people died, nine people hospitalized) Metakelfin (antimalarial) United Republic of Discovered in 40 Tanzania, 2009 pharmacies: lacked sufficient active ingredient Viagra & Cialis (for Thailand, 2008 Smuggled into Thailand erectile dysfunction) from an unknown source in an unknown country Xenical (for fighting United States of Contained no active obesity) America, 2007 ingredient and sold via Internet sites operated outside the USA Zyprexa (for treating United Kingdom, 2007 Detected in the legal bipolar disorder and supply chain: lacked schizophrenia) sufficient active ingredient Lipitor (for lowering United Kingdom, 2006 Detected in the legal cholesterol) supply chain: lacked sufficient active ingredient SOURCE: WHO Fact Sheet No. 275 (January 2010) www.who.int/mediacentre/factsheets/fs275/en/. pharmaceutical companies have been reluctant to complain publicly about fake drugs because it could damage their business.464 464 Robert Cockburn, Paul Newton, Kyermateng Agyarko, Dora Akunyii and Nicholas White, “The Global Threat of Counterfeit Drugs: Why Industry and Government Must Communicate the Dangers,” Plos Medicine (March 2005).
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NATIONAL SUPPORT FOR EMERGING INDUSTRIES 425 Looking Ahead The U.S. pharmaceutical industry continues to pursue growth strategies despite the numerous challenges it confronts. Major branded pharmaceutical companies will seek to offset declining R&D productivity through partnerships with innovative biotechnology firms, a strategy which also may help to counter competitive pressure from generics makers. U.S. pharmaceutical firms will increase investments in R&D in emerging markets, where demand for medicines is growing at a far more rapid rate than in developed country markets. And the industry will pursue niche strategies in areas such as biosimilars and orphan drugs. Strategic combinations. Pharmaceutical and biotechnology firms are increasingly entering into complex strategic alliances with other companies, including licensing and cross-licensing of patents, joint ventures, joint development and trials, and distribution alliances. Such combinations mitigate the costs and risks associated with development of new drugs and enable companies to enter new product and geographic markets. Development of biopharmaceuticals may also help branded pharmaceutical firms to counter competition from generic drug makers. The high cost of developing biologics such as monoclonal antibodies serves as a partial competitive foil to generics makers. On industry analyst observed in 2010 that— It's not going to be that easy for generic players to be very successful in the biotech area. They are not easy to copy and not easy to manufacture.465 In 2009 the CEO of Johnson & Johnson, William Weldon, said that J&J would acquire minority shareholding and develop alliances with its competitors in order to share costs and risks. [Weldon’s] remarks reflect a trend even by large, cash, generative pharmaceuticals companies to fund new ways to share the potential costs as well as the profits in proving the safety and efficacy of new drugs to regulators and winning agreement by health care systems to reimburse them.466 465 Rajith Gopinathan, analyst with industry market research firm Frost & Sullivan, in "Pharmaceutical Companies Seek Biotech Acquisitions to Boost Drug Pipelines," ICIS.com (February 12, 2010). 466 J&J Wants Deals with Rivals to Share Risk,” Financial Times (October 25, 2009).
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426 RISING TO THE CHALLENGE TABLE 6.7 Strategic Alliances in Pharmaceuticals Year Companies Activity 2008 Sequenom, Apply Sequenom genotyping to enhance MetaMorphix livestock DNA screening 2009 PRA International, LSK Joint management of clinical trials in Asia Global Pharma Services, Mediscience Planning 2009 Illumina, Agilent Scalable solution for researchers conducting targeted sequencing studies 2009 Eli Lilly, Cadila Heath Development of cardiovascular drugs care 2009 Johnson & Johnson, J&J acquires rights to Elan Alzheimer Elan immunotherapy program, 18 percent stake in Elan, and links to Elan partners Biogen Idec and Wyeth (Pfizer) 2009 Johnson & Johnson, Develop monoclonal antibodies for Crucell N.V. prevention/treatment of influenza 2009 Johnson & Johnson, Use joint trials to develop a once-daily Gilead HIV therapy 2009 GlaxoSmithKlein, Pfizer Combine experimental and existing HIV medicines with joint venture 2009 AstraZeneca, Bristol- Joint development of diabetes treatment Meyers Squibb drugs SOURCE: “Johnson & Johnson Completes Deal with Elan, Acquiring its Alzheimers Assets, “ Business Wire (October 14, 2009); “Johnson & Johnson and Crucell form Drug Discovery Collaboration,” Datamonitor (September 30, 2009); “MetaMorphix and Sequenom Agree to Build on Success,” Business Wire (January 9, 2008); “PRA International, LSK Global Pharma Services and Mediscience Form Partnership,” Datamonitor (January 15, 2009); “Illumina and Agilent Sign Co-Marketing Agreement,” Datamonitor (April 20, 2009); “PharmaChem, Cadila, Eli Lilly in Drug Development Deal,” Chemical Business NewsBase (March 31, 2009); “j&J, Gilead HIV Drug Wins FDA Approval,” Blomberg (August 10, 2011); “GaxoSmithKline, Pfizer Inc. HIV Venture Plans Russian Manufacturing,” Chemical Business NewsBase (November 3, 2011); “Onglyza Study by Bristol-Meyers Squibb and Astrazenica,”Asia Pulse ( June 29, 2010).
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NATIONAL SUPPORT FOR EMERGING INDUSTRIES 427 Emerging markets. Pharmaceutical markets are growing far more rapidly in emerging economies than in mature markets in the United States, Europe and Japan.467 The pharmaceutical industry will necessarily pursue growth by increasing its presence in emerging markets, particularly countries with large populations and rising standards of living.468 China. China is now the world's third largest pharmaceuticals market, is reportedly growing at a rate of over 25 percent per year, and is forecast to overtake Japan as the world's second largest market in 2016. In 2011, the government announced its intention to boost healthcare spending by 16.3 percent to about $26 billion. At present over 90 percent of China's population is covered by some form of insurance, making modern medicine more affordable. Demand is particularly strong for drugs to treat chronic illnesses, which account for 80 percent of deaths in China.469 In 2011, Merck indicated its R&D spending in China would reach $1.5 billion over the next five years, and that it would construct a 600-person R&D headquarters in Beijing.470 U.S. pharmaceuticals companies investing in China face a number of challenges, including government intervention in drug pricing, competition from locally- produced generics, and infringement of intellectual property. Major foreign pharmaceutical makers have made significant commitments in China.471 Novartis announced in 2009 that it would invest $1 billion in R&D in China over the next five years, augmented by acquisition of an 85 percent stake in one of the largest private makers of vaccines in the country, Zhejiang Tianyuan Bio-Pharmaceutical Co. Ltd. Eli Lilly opened an R&D center in Shanghai in 2008 and has entered into a venture capital initiative to launch new products in collaboration with Chinese institutes and companies.472 South Korea. Major U.S. pharmaceuticals firms are establishing a presence in South Korea, a country with a strong university and science infrastructure, a large pool of skilled manpower, and the ability to conduct 467 “A 2010 study by Thomson Reuters Pharma observed that demand for pharmaceuticals was growing at an annual rate of 25-27 percent in China and 15-17 percent in markets such as Brazil, India, Poland and Russia. Western European markets were growing at an annual rate of 1-3 percent and the United States 3-5 percent.” Thomson Reuters Pharma, “The Ones to Watch: A Pharma Matters Report,” (July-September 2010). 468 Merck has reportedly embraced an aggressive growth plan for emerging markets which would up its 18 percent growth rate in 2012 to 25 percent in 2013, focusing R&D in each country on products that are important for that country. "Merck and Company Firms Up Plan for Emerging Markets," The Economic Times (Mumbai, February 17, 2012). 469 "Alliances Form in Growing Pharmaceutical Market," Business Daily Update (August 3, 2011). 470 "Merck Play R&D Centre in China," Chemical Business Newsbase (December 12, 2011). 471 "Foreign Giants Dominate China Pharmaceutical Market," SinoCast (November 5, 2010). 472 "Eli Lilly Opens China R&D Headquarters in Shanghai,"SinoCast (October 17, 2008); "Eli Lilly Asia VC Fund Settles in Shanghai," SinoCast (November 16, 2007).
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428 RISING TO THE CHALLENGE clinical trials in an extremely efficient manner.473 Pfizer announced in 2007 that it would make Korea a "key research bank for its new medicine development" and invest $300 million over a five year period.474 In 2007, VGX Pharmaceutical Inc., a U.S. firm that specializes in hepatitis and HIV treatments, announced it would invest $200 million to establish its Asian headquarters in Korea.475 Johnson & Johnson manufactures drugs in Korea through a subsidiary, Janssen Korea, which functions as J&J's production base for the entire Asian market.476 Foreign pharmaceutical firms operating in Korea face significant challenges, including pressure by healthcare providers to give suppliers rebates,477 lack of transparency with respect to Korea's pricing and reimbursement of drugs,478 and government pressure on the intellectual property of branded drug firms.479 Biosimilars. The first generation of biotechnology drugs is going off- patent, giving rise to a promising new market for "follow-on biological," also known as biosimilars. A number of the major branded pharmaceutical producers are entering the biosimilars markets, including Merck, Eli Lilly, and AstraZenica. In contrast to small molecule drugs formed through chemical synthesis, biologics are molecularly complex and potentially sensitive to changes in manufacturing processes, raising the prospect that they might not have the same effects in human beings as the original drug.480 As a result, biosimilars face an uncertain regulatory path to approval which is still evolving 473 Korea has a unique advantage in the form of large hospitals in a dense area; with so many patients, clinical trials can be done quickly. In addition, Korean hospitals have strong links with university R&D organizations. "Novartis Stays Ahead with New Ideas: Country Head Says Dedication," The Korea Herald (March 31, 2004). 474 "Pfizer Pharmaceutical Company to Invest 300m Dollars in South Korea by 2012," Yonhap (June 14, 2007). 475 "US Drug Maker to Have Headquarters in Korea," Korea Times (July 9, 2007). 476 "Pharmaceutical Giant to Expand Korea Operations," Dong-A Ibo (February 18, 2008). 477 Since 2007, a significant number of manufacturers, including Eli Lilly, Pfizer and GlaxoSmithCline have been fined by the Korea Fair Trade Commission (KFTC) for illegal payment of rebates to hospitals, doctors and pharmacists. The U.S. government has noted concerns expressed by U.S. companies targeted by the KFTC that they have not been accorded a significant opportunity to review and respond to the evidence against them, including an opportunity to cross-examine witnesses at KFTC hearings. "10 Pharmaceutical Firms Face Heavy Fines for Rebates," Korea Times (October 25, 2007); "War Declared on Drug Makers' Rebates to Doctors," Dong-A Ilbo (July 31, 2009); "Cleanup Drive to Sweep Pharm Industry," Korea Times (March 31, 2009). Office of the U.S. Trade Representative, 2009 National Trade Estimate on Foreign Trade Business (2009) p. 316. 478 Imported pharmaceuticals are subject to multiple price reduction mechanisms under the Korean Drug Expenditure Rationalization Plan (DERP) cost containment measures, enacted in 2006, which affects not only drugs entering the market since DERP was adopted, but retroactively affects drugs approved for reimbursement in the pre-DERP era. Office of the U.S. Trade Representative, 2009 National Trade Estimates Report on Foreign Trade Barriers (2009) p. 317. 479 "ROK Firms Plan Tamiflu Generics Production," Korea Times (September 9, 2009). 480 The makers of follow on biologic drugs do not have access to the originating company's active drug substances, cell bank, molecular clone or fermentation and purification processes.
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NATIONAL SUPPORT FOR EMERGING INDUSTRIES 429 in the U.S. and Europe.481 The Patient Protection and Affordable Cure Act, enacted in 2010, establishes a 12 year period of data exclusivity for new biological drugs between the date of FDA approval and the filing date for biosimilar approval based on the innovator's original data, a measure which may inhibit the introduction of biosimilars. IN CLOSING The global competitive environment is being shaped to an important degree by the national policies of our competitors. This chapter has explored the major policy issues affecting the competitiveness of the semiconductor, photovoltaic products, advanced batteries, and pharmaceuticals industries. Each of these industries can be regarded as strategic to the United States. While many nations in Europe and Asia use the full force of government to attain commercial competitive advantage in industries they regarded as strategic, the idea of proactive government help for private industry in the name of economic development has sometimes raised concerns in the United States about distorting market forces and the wisdom of letting public servants “pick winners.” In reality, the U.S. federal government has long played an integral role in the early development of numerous strategic industries, not only by funding research and development but also through financial support for new companies and government procurement. Each of the four industries studied face unique circumstances and challenges. At the same time, they illustrate the important role that national investments have played in supporting their development and the need for public policies to ensure that the nation captures the benefits of these investments in terms of economic growth and high value employment. 481 In the U.S. the Biologics Price Competition and Innovation Act of 2009 was enacted in 2010 to create a shortened path to regulatory approval for biosimilars. The FDA is currently developing guidelines for the approval process for biosimilars. As of March 2012 it had not yet received its first biosimilars application. "Fitch Looks at Implications of FDA Biosimilar Guidance," Pharma Times (February 13, 2012).
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