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Determinants of National Pharmaceutical Competitive Acivantage Essentially, four broad hypotheses may be presented as explana- tions for the recorded shifts in competitive position of U.S. pharmaceutical firms. M icroeconomic factors--basic conditions of cost, input supply, and output demand have operated adversely for U.S. pharmaceutical firms. Macroeconomic factor~-the relative decline of the U.S. pharmaceutical industry is simply part of an economy-wide deterioration of American industrial position. Regulatory factors--the comparatively more costly and extensive regulations of the U.S. Food and Drug Administration (FDA) have disadvantaged U.S. firms. ~ A ~ ' do- _ ~ . if - ~rT~c~a~ economic supports and restraint~-the discrim- ~ natory tax and trade policies of foreign governments have unfairly advantaged foreign-located firms. Of these hypotheses, the first would appear to be of little explana- tory value, while the second provides an important but only partial accounting for the documented relative decline. The sequence of hypotheses considered below begins with three microeconomic aspects (1 abor costs, domestic growth of demand, and national supply of qualified scientists), next introduces macroeconomic, then regulatory aspects, and concludes with two discriminatory policy aspects (taxation and trade barriers). LABOR COSTS Comparative levels of wages and salaries are a generally impor- tant determinant of industrial location. The relative levels of compensation for both manufacturing and research staff among North America, western Europe, and Japan are thus potentially 53

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54 TABLE 3-1 Manufactunng Wages (1970=100) Hourly Earnings in Manufacturing Gross Earnings per Monthly Earrings Production Worker Hourly Rates in Manufactunng in Manufactunng West U.S. Germany U.K. France Italy Switzerland Japan 1960 67 44 57.0 44.9 41.2 60 31.1 1965 78 69 71.8 64.4 67.5 78 50.3 1970 100 100 100.0 100.0 100.0 100 100.0 1975 143 160 220.1 188.3 241.4 155 230.3 1980 216 216 439.9 374.4 63 1.7 180 345.2 SOURCE: "Main Economic Indicators," OECD, Pans, venous years. important sources of explanation for differential patterns of growth in research and production. Data on trends of general national compensation in manufacturing are reported in domestic currencies in Table 3-1. While rates of growth of wages in domestic currencies have varied widely during the last two decades, these domestic trends are mostly offset by opposite movements in exchange rates. Thus, while Swiss manufacturing compensation has risen more slowly than that in the United States, the Swiss currency has (until quite recently) persistently appreciated against the dollar. As a consequence, the dollar cost of Swiss labor relative to U.S. labor has moderately increased. Thus, this first potential explanation of the deterioration of the U.S. competitive position fails to account for the observed decline, as U.S. wages have not risen more rapidly than foreign costs. MARKET GROWTH Consumer demands for pharmaceutical products have increased in all nations, but at widely divergent rates (see Table 3-23. Data on consumption levels indicate that foreign markets have uniformly grown more rapidly than those of the United States. However, the parallel, extensive growth of foreign production is not com- pletely explained by these figures as they fail to indicate the reason this growth was met by production abroad rather than by U.S. exports.

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55 TABLE 3-2 Domestic Pharmaceutical Sales, Selected Countries, Selected Years (millions of dollars) 1965 1970 1975 Growth United States 3,121 4,701 7,387 9 Japan 1,298 2,975 6,402 17 West Germany 742 1,408 3,952 18 France 967 1,207 2,731 11 Italy 514 920 2,181 16 Spain 236 597 1,652 21 United Kingdom 300 408 815 10 NOTES: Growth figure is annual percentage growth rate. Sales are apparent consump- tion (production plus imports minus exports) except for US and UK. SOURCES: US PMA,PrescnptionDrugIndustryFactbook, PMA,Washington,D.C., 1976. ABPI, Annual Report, London, venous years. NATIONAL SCIENTIFIC CAPACITY The general research base of a nation would be expected to affect strongly the extent and success of industrial RED. One aspect of this research base is illustrated in Table 3-3, where the U.S. proportions of articles published in various fields are shown. Such American accomplishments not only fail to provide an explanation for the falling U.S. share of industrial pharmaceutical research and innovation, but suggest that no such trends should exist. A crucial aspect of the national scientific base is "over n- m ental and nonprofit expenditures on research, which in the United States amounts to about 75 percent of all healthrelated RED. Data on these expenditures are presented in Table 3-4 and demonstrate the stunningly large proportion of world health expenditures that the U.S. government funds. Indeed, it would appear (based on plausible extrapolation from Table 3-4) that the U.S. government expends, by itself, virtually as much for health research as do all other sources, both industrial and governmental, in the western developed nations. GENERAL RELATIVE DECLINE OF U.S. INDUSTRY The relative decline of the U.S. pharmaceutical industry is unfor- tunately not unique. Numerous American industries, if not our entire economy, have exhibited sustained decay of relative position over the past two decades. Several reasons exist for the relatively more vibrant growth of foreign economies. Much of

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56 TABLE 3-3 U.S. Proportion of the World's Articles, 1973-1977 (percentages) Field 1973 1975 1977 All 39 38 38 Clinical medicine 43 43 43 Biomedicine 39 39 39 Chemistry 23 22 22 Biology 46 45 42 NOTE: Articles are counted from the 271,000 to 279,000 articles, notes, and reviews per year from over 2,100 of the influential jour- nals of the Science Citation Index, Corporate Tapes of the Institute for Scientific Information. SOURCE: National Science Board, Science Indicators 1976, Na- tional Science Foundation, Washington, D.C., 1977. European and Japanese manufacturing capacity was devastated by World War II, and postwar recovery of these economies brought on inevitable correction to the early 1950s economic dominance of the United States. Secondly, particularly in the case of Japan, standards of living abroad were historically below those of the United States, and the international diffusion of manufacturing technology brought a leveling of national productivities that implied more rapid growth abroad. Finally, differences in national industrial policies and management procedures contributed to the differential national economic records. By the mid-1970s, three decades after World War II, the latter policy differences were probably preeminent in significance. Tables 3-5 and 3-6 indicate that decay in U.S. shares of sales and innovation has occured for many industries, not just pharma- ccuticals. These general relative declines suggest that if deterior- ation of competitive position in the pharmaceutical industry is no worse nor no better than that of most industries, especially most high-technology industries, then there is no need for arguments unique to the pharmaceutical industry to explain these firms' relative decline. Instead, contemporary economy-wide factors such as taxation, investment policy, export policy, national levels of savings and investment, and so on must be invoked as hypotheses. From this viewpoint, Tables 3-5 and 3-6 would suggest precisely that no such additional industry-specifi c explanations are needed in the case of the pharmaceutical industry

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57 TABLE 34 Sources of Expenditures for Health Research and Development, Selected Nations (millions of dollars) Pharmaceutical Year Industry University Government France 1969 63 7 na West Germany 1972 310 na 168 Switzerland 1975 244 17 na United Kingdom 1972 108 3 200 United States 1972 535 50 2,223 SOURCE: Organization for Economic Cooperation and Development, Impact of Multina- tional Enterprises on National Scientif c arid Technical Capacity: Pharmaceutical Industry, O.E.C.D., Paris, 1977. Figure 3-1 and Table 3-7 suggest otherwise. Figure 3-1 demonstrates that the pharmaceutical industry has behaved uniquely among the west European and Japanese chemical induce tries, while in the United States, the performance of the pharma- ceutical industry is literally indistinguishable from other com- ponents of the general chemical industry. Something unique indeed has occurred. More significantly, Table 3-7, when com- pared with Table 2-1, suggests an even more profound difference. The U.S. share of world chemical R&D has fallen only moderately during roughly the same time period when the U.S. share of phar- m aceutical R&D has drastically dropped. Indeed, none of the industries subject to the OECD study that underlies Table 3-7 exhibits a fall or research share that in any way parallels the severity of the drop in the pharmaceutical industry. For an explanation of those factors that have so severely affected relative U.S. pharmaceutical R&D, attention must be turned elsewhere. I NDUSTRIAL POLICY: REGULATION The costliness and success of pharmaceutical innovations ar e vitally affected by regulation of drug safety and effectiveness. The detail and pervasiveness of this regulation in the United States are almost unique, both in comparison with U.S. regulation of other industries and with foreign regulation of pharmaceutical markets. Further, the scope and volume of U.S. pharmaceutical regulations have dramatically expanded since 196 0, suggesting that changes in this component of U.S. industrial policy may well have provided substantial effect on the competitive position of U.S. firms.

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58 TABLE 3-5 Sales of Major U.S. Corporations as a Proportion of Major World Corporations, Selected Industnes, 1959 and 1978 (percentages) 1959 1978 High Technology Industries Aerospace 95.4 90.1 Chemicals 66.3 31.9 Electron~cs-appliances 75.6 46.9 E'harmaceubcals 61.1 35.0 Other Industries Automotive 84.3 59.7 Food products 66.6 55.7 General machinery 61.7 51.8 Metal manufacturing 89.9 32.4 Metal products 66.8 43.2 Paper and paper products 92.2 70.6 SOURCE: Nestor Terleckyj, "Technology and the Changing Posi- tion of U.S. Firms Among the World's Largest Companies," paper Oven at the December 1979 meeting of the New York State Bar Association, Antitrust Law Section. Original data from Fortune (Jlily, August 1960 and May, July, August 1979). Legislative foundations for regulation of ethical drugs in the United States are the Food and Drugs Act (1906), the Federal Food, Drug, and Cosmetic Act (1938), and the (Kefauver-Harris) Drug Amendments (1962~. The essence of this regulation, since 1938, has been premarket approval by the U.S. Food and Drug Administration (FDA) for any new drug product. In other words, commerce for a new drug is prohibited until it is adequately tested for safety and, since 1962, for effectiveness in treatment for indications prescribed on its label. Exemptions to this require ment are allowed only for investigational use by qualified scien- tific experts. The basic mechanics of this requirement involve submission of data in the form of an N DA. Before 1962, unless the FDA acted to reject the NDA within 90 days of submission, the new drug could be marketed. Impor- tant changes in FDA requirements emerged after adoption of the 1962 Amendments. Central provisions of the Amendments are: . Effectiveness must be demonstrated by the manufacturer through "adequate and welLcontrolled investigations" to obtain FDA approval of an NDA. FDA monitors investigational drug studies in humans by requiring data in the form of a Notice of Claimed Investigational Exemption (IND). If FDA vetoes the IND, testing in humans may not begin.

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59 TABLE 3-6 Patents Granted to U.S. Applicants as Proportion of Total U.S. Patents, Selected Industries, 1963 and 1973 (percentages) 1963 1973 Change . All industries 80.5 68.2 -12.3 Aerospace 74.9 58.8 -16.1 Chemicals 74.3 63.1 -11.2 Electrical 83.6 69.8 -13.8 Pharmaceuticals 64.0 54.7 -9.3 SOURCE: Nestor Terleckyj, "Technology and the Changing Position of U.S. Firms Among the World's Largest Companies," paper given at the December 1979 meeting of the New York State Bar Association, Antitrust Law Section. . FDA must affirmatively approve an NDA, rather than allowing automatic approval after 90 days. FDA must establish good manufacturing practice regulations. Many scholars have argued that the 1962 Amendments were responsible for greatly increasing FDA regulation. Following the 1962 Amendments, the scope and intensity of U.S. pharmaceutical regulation significantly increased. A closer examination suggests that the specific requirements of the 1962 Amendments do not fully account for all post-1962 changes in FOA regulation. Some of the contemporary structure of regulation for new drugs might have emerged without congressional adoption of the Amend- ments. In a recent essay, David Weimar has postulated how the IND procedure might have developed: Under Section 505(i) of the 1938 Law, the FDA had authority to promulgate regulations that governed th e distribution of drugs for investigational use. The regula- tions initially issued by the FDA required manufacturers to keep records of the distribution of drugs for investigational purposes, investigators to sign statements that they had adequate training and facilities to safely conduct the invest tigations, and labels to contain the statement, "Caution: New Drug--Limited by Federal Law to investigational use." These regulations permitted the distribution of thalidomide to over 1200 physicians. The same furor that led to passage of the 1962 Amendments prompted the FDA to revise its regulations for investigational drugs. In August of 1962, prior to passage of the Kefauver-Harris Amendments, the FDA published regulations that in effect established an IND procedure. They required that only

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60 280 260 240 220 180 160 140 120 100 80 Western Europe ; r . l Hi_ ,11 Japan t . 1 1 1 1970 1972 1974 1976 1970 1972 1974 1976 1970 YEAR United States Chemical industry ~ Ethylene - Sulphuric acid 0~0 Dyestuffs Plastics materials Paints and varnishes Soap and detergents Pharmaceutical products . ! . ! row I ! 1 1 1 1972 1974 1976 FIGURE 3-1 Trends in Production in the Major Branches of the Chemical Industry SOURCE: OECD, The Chemical Industry, Paris, 1978.

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61 TABLE 3-7 U.S. Share of industrial R&D Expenditures in Nine OECD Countnes, 1967 and 1975 (percentages) 1967 1975 Change Aerospace 81.5 72.6 -8.9 Electrical 66.3 57.4 -8.9 Chemical 44.5 40.2 -4.3 Other transport 58.7 48.7 -10.0 Machinery 55.2 53.2 -2.0 Basic metals 37.8 40.1 +2.3 Chemical-linked 43.0 43.1 +0.1 Other manufacturing 49.7 49.8 +0.1 NOTE: Countnes surveyed include U.S., Japan, West Germany, France, U.K., Bel- gium, Italy, Canada, and Sweden. SOURCE: Organization for Economic Cooperation and Development, Trends in Industrial R&D in Selected OECD Member Countries, 1967-1975, OECD, Paris, 1979. qualified investigators be used; that their qualifications be filed with the FDA; that drugs be tested on humans only after animal testing; that the FDA be kept fully informed of the results of the testing, and that special precautions be taken in the testing of drugs intended for use by children or pregnant women. This is one of several instances we will encounter where proposed legislative changes have been anticipated in FDA regulations.] Nonetheless, it is clear that the 1962 Amendments and particularly the new requirement of affirmative FDA approval of an NDA-~ad a major impact on regulatory requirements for new drugs. An uninterrupted series of requirements (some explicitly required by the 1962 Amendments and others adopted as adjuncts to those Amendments) have been issued since that year, a partial listing of which follow: 1963 Regulations specify good manufacturing practice. 1966 Preclinical guidelines issued for teratology and Derinata1 and Dostnatal studies reproductive, 1968 Preclinical guidelines issued for toxicity testing. 1970 Regulations specify requirements for '~welFcontrolled investigations" to produce '"substantial evidence" of efficacy. 1970 flay delay for initiation of testing in humans after submission of IND.

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62 1972 Preclinical guidelines issued for chemistry, expanding requirements for drug manufacture. and aualitv control. 1 975 1 977 1978 ~ _ _ _ _ , _ , _ , _ Freedom of Information Act regulations issued. Clinical guidelines issued for various drug classes. Regulations specify Good Laboratory Practices. These regulations issue standards for test protocols, quality control, recordkeeping, equipment, buildings, and facilities, etc. The impact of the 1962 Amendments was heightened by two factors. A first factor has been scientific advancement- in medic Cal technology that enables Norm acute detection of potential adverse reactions. As the ability of researchers to test for safety and efficacy improved, the expectations and requirements of the FDA increased for the volume and quality of premarket testing. The second and most critical element, however, has been intense political pressure on the FDA. The very nature of the premarket approval system confronts the FDA with difficult choices. The limited clinical trials used statistically to ascertain safety and effectiveness of new drugs cannot possibly provide, with certainty, estimates of the extent of therapeutic benefits and of adverse reactions. Any drug potent enough to be effective carries some risk of adverse reaction in humans and adverse results in test animals. It is widely known, for example, that penicillin has fatal effects on guinea pigs and aspirin has term tological effects on animals (suggesting that either product would today encounter severe regulatory obstacles for approval by the FDA). Under these circumstances, the FDA must weigh patient risk of adverse reactions against patient risk of disease due to inferior or no pharmaceutical treatment. This complex calculus must inform FDA decisions as to what tests, guidelines, and requirements should be enforced on pharma- coutical firms seeking clearance for new products. Yet, the American political process places substantial pressure on the FDA not to approve new drugs. The Congressional Information Service Index for 1969 and 1970 reports congressional hearings on FDA decisions concerning 38 specific drugs or drug classes. Of these hearings, only two questioned FDA decisions not to approve marketing of drugs; one of the latter hearings was on laetrile. Former FDA Commissioner Schmidt, in 1974, summarized the impact of this political pressure as follows: In all our history, we are unable to find one instance where Congressional hearings investigated the failure of FDA to approve a new drug...iT]he message conveyed by this situation could not be clearer....Until perspective is brought to the legislative oversight function, the pressure from Congress for F DA to disapprove new drugs will continue to be felt, could be a major factor in health care in this country.2 and

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63 The process of regulation in other nations differs significantly in several respects from that in the United States, generally being m ore flexible and prompt. A recent U.S. General Accounting Office (GAO) report has identified several key distinctions in operation of pharmaceutical regulation abroad, some of the more important of which are excerpted below. Greater Use of Expert Committees In most European nations, decisions on approval o f n ew drugs are not solely the responsibility of career bureau officials; but instead, these decisions are either substantially advised or formally made by committees of independent medical experts. According to European regulatory and industry officials, using a committee of experts insulates th e regulatory authority from public criticism, gives credence to the final decision, and expedites the review and approval of drugs. Some European committees of experts are mandated to review all drug applications and either approve a drug when it is shown to be safe and efficacious or recommend to the regulatory agency that a drug should or should not be approved. In three countrie~-the Netherlands, Norway, and Sweden--the committees had been given the responsibility to make the decision to approve, reject, or withdraw a drug. The United Kingdom's committee only advises the government agency on the safety and efficacy of a drug; however, we were told that its recommenda- tions have always been followed. At FDA, committees are used to provide advice on problems or questions FDA may have concerning selected drug applications. However, applications are not su ~ misted routinely to the committees in the United States as they are in foreign countries. FDA has sole respo n- sibility for making a decision on an application based on the scientific data submitted and any advice from the expert committee. Greater Acceptance of Foreign Data The traditional refusal by FDA to accept foreign data as a basis for NDA approval has required costly delay and new testing.

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64 Foreign clinical study data are accepted by most foreign drug regulatory agencies as evidence of a drug's safety and efficacy if the studies are welLconceived, well~ontrolled, performed by qualified experts, and conducted in accordance with acceptable ethical prin- ciples. Domestic verification is sometimes required. According to foreign government officials, the degree of additional domestic verification depends on such factors as the source of the original clinical trials, since medical practices and hereditary, dietary, and other factors may be different from those of the registering country. Some countries--the Netherlands, Norway, and Switzerland-- accept foreign data submitted without domestic verifi- cation depending on the source. Other countries-- Sweden, and the United Kingdom- will normally request some domestic verification. Although the FDA may have accepted, in some cases, foreign data as pivotal evidence of the safety and efficacy of a drug, its policy in this regard is not clear. Officials of the drug firms we visited, indicated that FDA would not accept foreign data as primary pivotal evidence, and required that the safety and efficacy of a drug be supported on the basis of duplicate domestic studies. FDA's Director of the Bureau of Drugs stated that FDA has had a reputation for not accepting foreign data. We believe FDA needs to formally clarify and communicate its policy on the acceptance of foreign data. Less Politicization of Drug Approval Process In the European countries we visited, drug regulatory officials told us there was no direct parliamentary or con- sumer scrutiny on the drug regulatory process. When a parliamentary body wishes to inquire about issues co n- cerning drug regulatory policies, procedures, or decisions, drug regulatory officials are not required to appear before the parliament and thus are not subjected to parliamen- tary pressures. Rarely, if ever, is the regulatory agency's director or any of its employees asked to appear before the parliament. Instead, the minister of health, who is a m ember of the parliament, responds to inquiries from parliament on drug regulatory matters. Foreign drug regulatory officials advised us that members of parliament in their countries, for the most part, believe that the regulatory agency has primary responsibility for regulating drugs and that parliamentary involvement should be minimal.

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65 FDA's drug regulatory process comes under intensive congressional oversight and scrutiny by consumer-oriented organizations. Officials of many U.S. drug firms told us that congressional and consumer scrutiny tends to slo w FDA's drug approval process. Greater Cooperation between Regulators and Industr y M ost foreign drug industry officials explained that they have easy access to British, West German, Swiss, Norwegian, and Swedish experts and drug regulatory officials for frequent and open scientific discussions off the record. According to these officials, scientific discussions address the tests necessary for approval and other difficulties, and in their opinions assist in deveL aping a framework for clinical trials. American drug firm officials told us that FDA appears to favor an adversary relationship with industry. Bureau c1 Drug reviewers, according to these officials, review an application with the attitude that there are errors in the application and that they must find them. This adversary attitude is compounded by a communica- tions problem between FDA and industry. According to drug firm officials, FDA has become increasingly inaccessible. One drug firm official told us "Industry is becoming more isolated from FDA. Bureau of Drug reviewers will not use phones to ask us questions they have on an NDA." Another drug firm official, in comparing F DA reviewers with their European counterparts said, "Medical officers are a lot more open and frank in Europe. As a result, they are able to resolve problems with ND3A submissions in a more timely manner in Europe. " A clearly demonstrable effect of the totality of differences between FDA regulation and that abroad is longer approval times in the United States as compared with most other nations. The above cited GAO report indicated that the mean times between application for marketing new drugs and regulatory approval of applications are as follows (for selected nations>. Canada Norway Sweden United Kingdom United States 1 6 months 1 7 months 28 months 5 months 23 months

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66 TABLE 3-8 Companson of U.S. NCE Introduction Dates with UK, France, and West Germany (all U.S. NCE introductions between 1963-1967) Country and Year Number (Percent) Introduced of U.S. Introduction Before U.S. Same Year After U.S. Not Abroad United Kingdom 196~1967 30 (48) 12 (19) 21 (33) 13 1968-1975 44 (61) 14 (19) 14 (19) 26 West Germany 196~1967 21 (46) 12 (26) 13 (28) 28 1968-1975 39 (56) 17 (24) 14 (20) 30 France 196~1967 11 (27) 4(10) 26(63) 31 1968-1975 26 (45) 9 (16) . 23 (40) 43 SOURCE: Henry Grabowski, "Regulation, The Innovative Process, and International Diffusion in the Pharmaceutical Industry," mimeograph, 1979. The GAO report further identifies several important drugs that have been introduced abroad significantly earlier than in th e United States. An inevitable effect of FDA delay in approval of new drugs is earlier introductions of new pharmaceutical products abroad. The United Kingdom and West Germany now receive NCEs earlier than does the United States, and the U.S. position has moved from one of lead to lag as regards the diffusion of pharmaceutical innovation, as can be seen in Table 3~. An additional impact of increased U.S. regulation of the phar- maceutical industry has been increased costs of development for NCEs. As the recent study for OTA by Leonard Schriffin explains: Regulations of the sort contained in the 1962 Amend- ments raise a firm's costs of drug development by requiring inputs into the RED process, reduce its chances of Rtc D success, and delay the time of paym ff for successful innovation. Economic theor>, tells us what further to expect from such cost increases. For one thing, they will alter the amount of RHO activity: firms finding it commercially infeasible to attempt to innovate will find that to be even more the case; those finding it marginally profitable to do so, may well find it now to be unprofitable; and firms that are active innovators will find that fewer of the available projects w ill remain advantageous to pursue. Thus, while the total

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67 dollar volume of RED outlays may be increased, there will be fewer inputs and outputs than otherwise associated with R6c D activity. The evidence is quite clear that, although RED costs were rising prior to 1962, the Amendments accelerated the trend. These cost increases have influenced firm strategies dim cernibly, if unevenly, and the overall [U.S.] rate of innovation has been reduced as a result.4 The relatively early assessment of new drug candidates in the clinic is a particular advantage available to firms conducting research abroad. Probing studies of efficacy in patients must now be preceded by long and costly laboratory studies. The clinical usefulness of cortisone and even penicillin would have been seriously delayed under today's regulations in that they would have required the production of at least 20 to 30 Kg of cortisone before it would be allowed in the clinic. With the process as it stood from the first synthesis of about 10 to 15 grams of cortisone per 1000 pounds of desoxycholic acid, no company could have afforded to undertake the herculean task of meeting todays requirements. Another aspect of the same situation is the selection of the best candidate for clinical studies. Today, it is a very sizeable task to take several related compounds to the clinic in order to determine which one would be the best to develop, a procedure that can more easily be done abroad. While American companies may be allowed the same opportunities to test several related compounds in patients at the same time, it would be very difficult to do so because the RED expertise and organization knowledge able about the drug candidates are located in the United States. This situation places American companies at a disadvantage. INDUSTRIAL POLICY: TAXATION Specific tax policies that benefit the pharmaceutical industry are not common among the major OECD nations. The most prominent examples of such policies occurin Japan. In the first place,Japan allows special tax treatment for industrial research and develop- m ent expenditures. The relevant regulation is Tax Special Treatment Article 42-3. It states that a corporation can enjoy a tax credit if its net research expense spent and tax deductible in the current fiscal year (i.e., gross expense minus any subsidies from affiliated companies, government and others) exceeds the expenses of any previous fiscal year since 1967. In that event, 20 percent of the excess (i.e., current research expense minus the maximum expense of any year since 196 7) is deducted fro m corporate tax for the year. A simple example would be:

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68 Company Research Expense Government Research Grant Net Research Expense Hi ghest Research Expense of any year since 1967 Difference 20% of 200 = 40 Total Corporate Tax for Year (say) Less 20% of 200 Net Tax 31,000 _ 100 900 700 200 __ 1,500 40 _~ 1,460 - Further, Japan maintains not one, but two agencies for pub- licly funding pharmaceutical research. The first is the Research Development Corporation- of Japan, which finances technological work in all industries. Its most recent fundings have been: 1980 Green Cross Co. 34.2 Million 1978 Kaken Yakkako Co. 3.8 Million 1977 Teijin Co. 2.9 Million The second agency is the Council for New Drug Development Promotion that funds only pharmaceutical research . Recen t Council expenditures have been: 1980 Kyoto University 30.8 Million 1979 Takeda Chemical Co. Q9 Million These findings make up a pitifully small proportion of Japanese national expenditures on pharmaceutical research and deveL opment. Yet, because these public grants are directed toward basic research, their impact is presumably larger than simple percentages of total expenditures would indicate. INDUSTRIAL POLICY: TRADE Tariffs are of little consequence to the pharmaceutical industry. Rates are usually low and do not generally seriously affect trade. Non-tariff barriers are of much greater importance. Many nations forbid the importation of finished pharmaceuticals, and almost all require prior authorization of any medicinal import. Further, safety regulation may be manipulated to favor domestic producers.

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69 A recent OECD report provides succinct characterization of the pharmaceutical trade policies of France: French policy offers an interesting example of the imaginative use of import restrictions. All phar- maceutical imports must be assembled and packaged in France. Ethical drugs require a visa from th e French authorities before they can be marketed. To obtain a visa, the manufacturer must submit com- plete details of the production process and analytical control methods, together with the testimony of experts, drawn from a list of approved experts, concerning the safety and efficacy of the product. In practice, a visa is only granted if the material is produced and clinically tested in France. The visa system leaves much to the judgment of the individual examiner; it can be and apparently often is, applied in such a way as to favor French firms rather than the affiliates of foreign companies.5 An additional example of non-tariff barriers derives from price regulation for ethical drugs. In the United Kingdom, allowable prices have been based on the costs of bringing a drug to market, and in the mid-1 970s, British authorities allowed research and development expenditures in the United Kingdom, but not elsewhere, to count as "costs" for the determination of price. Firms therefore had clear incentive to perform RED in the United Kingdom that might otherwise have been executed in the United States. Continental price regulations have on several occasions been used to pressure U.S. firms into locating product facilities in western Europe. An additional non~tariff barrier to U.S. exports of pharmacy ticals is, perversely enough, a U.S. policy. FDA regulations on new ethical drugs apply to exports as well as to domestic sales and, hence, prevent export of any new drug until it is approved for sale in the United States. This restriction holds even if the prod- uct has been formally approved for marketing in the importing nation Given the substantial relative delay of the FDA in approving new drugs, transparent incentives exist for U.S. firms to manufacture new drugs abroad for sale, rather than export them from the U.S. production. SUMMARY This assessment of possible causes for the decline in U.S. pharma- ceutical competitive position leads to several conclusions. In the

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70 first place, there are numerous similarities between the drop in pharmaceutical competitiveness and the general relative decline of the U.S. economy against Japan and western Europe. Specifi- cally, deterioration in U.S. shares of pharmaceutical exports, national ethical drug sales, And some aspects of pharmaceutical innovation such as patents are matched by comparable relative d eclines in many U.S. industries, including others in the high- technology sector. Adverse shifts in these specific features of competitive position are thus best explained by the more vibrant multi-industry growth of foreign economies and not by factors specific to the ethical drug industry. A second and quite important conclusion, however, is that two aspects of pharmaceutical competitive position have not followed this general trend but in fact have declined uniquely more severe- ly. The U.S.-located share of worldwide production has dropped steadily throughout the 1 960s and 1 970s in a way that is unmatched by production shifts in other chemical industries. The explanation for the distinctive performance of pharmaceutical production is straightforward--more rapid growth of demand abroad coupled with widespread non-tariff barriers in other countries that effectively require domestic production and drastically reduce the viability of export strategies. The largest U.S.-owned firms have adapted to these developments by estate fishing production facilties abroad, and thus the decline in world- wide sales of U.S.-owned firms has been much less severe than the drop in U.S.-located production. The outcome here is a clear loss of jobs and income for the territorial United States and a disad- vantage of indeterminate and possibly minor significance to r U.S.-owned multinational firms. The other pharmaceutical trend that differs from the general relative decline in the American economy is both more significant and of more ambiguous origins. The severity of the continuing drop in the world share ' of U.S.-located (and expectedly U.S.- owned) expenditures for pharmaceutical research and develop- ment is apparently unmatched in ' other related industries of our economy. This trend is particularly disturbing because ROD for new products is the foundation of the modern ethical drug indus- try and the essential basis for pharmaceutical competitive advan- tage. Traditional microeconomic factors such as labor costs or resource availability fail to explain this distinctive trend, and by process of elimination leads to government policies as the most likely caus - Moth U.S! government policies that relatively dis- courage pharmaceutical innovation and foreign policies that relatively encourage innovation abroad. To the extent that these public policies make the U.S. economy a less conducive environ- ment for pharmaceutical innovation, all major ethical drug firms are affected because of the preeminent size of American con-

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71 gumption in the increasingly integrated global market for ethical drugs. U.S. - wned pharmaceutical firms are, however, affected more so because higher proportions of their sales and research are drawn from IJ.S.-located activities. In the end, the greater sus- ceptibility of a corporation to U.S. government policies is the essence of what it means to be an "American" firm. While the divergent government policies that have combined to make the United States a less hospitable environment to r pharmaceutical innovation can be listed, it has not been possible within the limits of this study to determine the relative signifi- cance of each specific policy. Given the complexity of the issue, such detailed policy evaluation may never be feasible. This ambiguity should be a source of caution, but not of indecision in consideration of policy reforms. The economic stakes are large, and the issues raised are often quite general. While refusal to confront these issues is itself a policy option, the merits of such an option are dubious. NOTE S 1. David Weimer, "The Regulation of Therepeutic Drugs by the FDA: History, Criticisms, and Alternatives," Discussion Paper No. 8007, Public Policy Analysis Program, University of Rochester 2. Alexander Schmidt, "The FDA Today: Cities, Congress, and Consumerism," speech to the National Press Club, Washington, D.C., October 29, 1974, cited in Henry Grabowski "Public Policy and Innovation: The Case of Pharmaceuticals," Technovation, 1982,pp.157-189. 3. U.S. General Accounting Office, FDA Drug ApprovaL-A Lengthy Process that Delays the Availability of Important New Drugs, HRD-80-64, May 1980. 4. Leonard Schriffin, "Lessons from the Drug Lag," report to Office of Technology Assessment, June 1980. 5. Organization for Economic Cooperation and Development, Impact of Multinational Enterprises on National Scientific _ . . Capacity: Pharmaceutical Industry? Paris, 1977.