September 6th, 2009

Buried in the very long thread at Crooked Timber wastefully eviscerating Megan McArdle’s data-free and slanted musings on medical research is a very interesting nugget of actual fact from Daniel Davies (comment 132 (sic)). This deserves more fame:

For Glaxo [GSK], the USA is 39% of revenues by location of customer and 30% by location of subsidiary, but only 27% of operating profit (source: p.116 of the 2008 annual report, which is page 118 of the pdf file.)

Well, well. DD couldn’t find similar breakdowns for other companies. GSK is an intelligent and aggressive company, but no more than its competitors, so the working Bayesian assumption is that since Pfizer (US) and Roche (Swiss) face the same pressures in the same environments, the results are unlikely to be very different. National health insurance isn’t bad for Big Pharma: after all, six of last year’s top ten companies by sales are based in countries that have it. The list is unstable, as the blockbuster drugs go through their life-cycles, but here they are:

Biggest Pharma in 2008

What possible explanations are there for DD’s finding? National health care does squeeze prices; American patients and insurers pay twice as much per pill as the European average (here, table 5, page 14). We can I think rule out differences in manufacturing, distribution, regulatory and administrative costs: the industry’s costs are mainly R&D and marketing. (WHO: “After marketing costs, R&D is typically the second biggest item in the spending profile of large pharmaceutical companies.”)

I see two hypotheses:

1. The GSK accounts are no basis for anything because the company (like presumably its competitors) is gaming the numbers to avoid tax, labelling R&D costs as US-based because they are tax-deductible, shifting profits through transfer pricing to low-tax jurisdictions, etc. Plausible, but can you really get away with this for billions rather than millions? Tax domicile would matter a lot here, and GSK is a British company, so the direction of the effects may not generalise. Big Pharma relies heavily on government goodwill, and has very strong incentives not to risk killing the goose that lay such golden eggs by behaving like hedge funds over tax. Count me very sceptical.

2. Evil healthcare socialism constrains marketing expenditures for all participants. These are larger than R&D so the impact would be considerable. Only the USA allows marketing of prescription drugs to consumers: that’s an asymmetric $4bn a year extra for the industry alone. I suspect American rules on junkets (travel to conferences, continuing education seminars in the Caribbean) are weaker, though I may be wrong. The big difference arises from a far looser and more diverse structure. Take the British NHS. What’s the point of flying the board of the Rochdale Primary Health Care Trust to Cancun? They aren’t allowed to take such perks (as I read the rules), and anyway take their pharmaceutical decisions from NICE.

The companies will of course try to game any system. Bribing NICE would on paper be cost-effective but it’s horribly dangerous: there’s a very high risk of failure, discovery, disgrace and even jail. The Orwellian-named NICE is of course staffed by very thick-skinned and doubtfully nice people, and it works under intense public and professional scrutiny. The pricing negotiations are a lot less transparent. There was recently a scandal in Italy. When I started to live in France, the Sécu used to reimburse a lot of harmless me-too formulations with aspirin, vitamin C and the like, presumably to prop up a weak domestic drugs industry: less when I left. Anyway, even if such practices do restore rents to the industry, they do so at much lower overall cost than the marketing fiesta in the USA.

To the extent that drugs marketing is a zero-sum arms race, all the corporations benefit if it’s forcibly cut back.


Here’s Dr. Jeffrey F. Caren, a cardiologist in Los Angeles, with a display of the hundreds of pens given to him by the drug industry:

Dr Raren's pens

Pens are only the tip of the iceberg. Even in tightly regulated Britain (gift limit to GPs £6 – here, section 18.2), the pukka Royal College of Physicians (here, 3.31) angrily asserts that

.. Relentless pressure on doctors, exerted by pharmaceutical marketing masquerading as education, is common.

How much worse can it be in the USA?

Footnote on Megan McArdle

I’m less inclined than Mark to cut McArdle [Update: cheap shot play on her name removed, sorry, we don't choose them] any slack, she’s not an obnoxiously clever undergraduate (memory lane …) but a paid journalist under a professional obligation to check her facts, which she doesn’t. Her baseless assertion that the USA is responsible for “80-90%” of medical innovation is a dinner-party-circuit factoid. The USA is responsible for just under half (WHO: 42% in 1998, here table 2.2; British government: 49%, year not given) of world pharmaceutical R&D. To read her, you would think that only American teams could have come up with the discovery of the HIV virus, a gene therapy path to an AIDS cure, monoclonal antibodies, the bacterial origin of ulcers, computer tomography for scans, heart, hand, and face transplants, collagen scaffold trachea transplants, and the big daddy, the cracking of the genetic code. Would any of them have been possible without American science? Surely not: but interdependence works both ways.

The big difference between the USA and the rest of the developed world in medical research isn’t anything to do with Big Pharma, but the asymmetrical high public funding through the NIH: about half. Germany (here, table 2.2) and Britain (idem, figure 2.2) have much lower ratios of public to private health research expenditure – I guess the same would hold for Japan. So I agree with Mark that some burden-sharing would be fair.

This is all the more necessary in that there’s growing evidence that the Big Pharma model of innovation is broken. Quite apart from the shoddy marketing of diseases to fit the drugs available, and the natural bias towards the maladies of the well-heeled, the pace of real innovation has slowed. But should we be surprised? Having rival research teams work competitively in secret was the plan the Third Reich chose to develop a German atomic bomb, with the success we know. The academic, DARPA, and open-source model of competition plus full information-sharing seems to work a lot better. If national health care leads to a further socialisation and internationalisation of medical research, we should see that as an opportunity not a problem.

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12 Responses to “Why is national health care good for Big Pharma?”

  1. Barry says:

    “I’m less inclined than Mark to cut McArdle any slack, she’s not an obnoxiously clever undergraduate (memory lane …) but a paid journalist under a professional obligation to check her facts, which she doesn’t.”

    Frankly, I figure that Mark made the classic mistake of meeting somebody in person, and being led astray by personal charm, when their writings d*mn them very thoroughly.

    Megan started off as ‘Jane Galt’, which of course implied Randism. Her writings are pretty much in line with an Objectivist. The current thread on CT is the third one in which she’s been rightfully trashed, on healthcare alone. Considering that her fiance is an astroturfer, currently working with Dick Armey on healthcare fraud, this means that she’s already in serious Beltway media incest. She has time to research the background of an NYT reporter who filed for bankruptcy and wrote a book about it, but I’ll not hold my breath for her breaking the story of GOP lies and fraud about healthcare (unless she loses her job, and decides to write a ‘tell all’ story).

  2. karen says:

    Megan seems to think that everyone in all endeavors is motivated solely by money. I don’t know if she personally knows any scientists. Ayn Rand’s heroes are not primarily motivated by money, they just want to reap the rewards of their very constructive labor. I think Rand would classify most of those who make serious money in American business today among the parasites.

  3. Tim Worstall says:

    Couple of points.

    1)Corporate income tax rates in the US are significantly higher than they are in the UK. So yes, you would expect to see significant profit shifting and yes, it can be done with billions not just millions (place the patent in an offshore company and charge every national company for access to that patent is one of the simpler ways). Just as another example, the UK has a 125% R&D tax credit just to confuse matters.

    There’s even more about taxes. UK corporate income tax is not charged on dividends, unlike the way it is in the US. US system charges on all profits and then there’s a further tax (15%) on dividends paid out. UK system (in fact, the entire rest of the world) either taxes all profit and then does not tax dividend income to the recipient or corporate tax is paid only on retained earnings and dividends are taxed at the level of the recipient.

    All international companies fiddle the system in the face of these (and other) points and you’ll not discover anything useful about where people are making their profits by looking at their published accounts. Sorry, but you won’t.

    2) Might be worth looking up William Baumol on invention and innovation. NIH invents a lot of things, sure, just like state funded labs do all over the world. But innovation (in Baumol’s terms) is something a little different. That’s the getting of an invention out into general use right across the marketplace. That is something that the US medical system does faster than others. And that is where, given the 17 year limit on patents, pharma makes its money.

  4. James Wimberley says:

    Tim: thanks for the material on tax. But if the data are worthless, is there any longer any reason to think that the US market is particularly profitable? We know that prices are much higher, but so are the marketing costs. Agnosticism takes you the same place as DD’s figures. And the USA isn’t subsidizing the world.

    On innovation: “That is something that the US medical system does faster than others.” Any evidence that (leaving aside other medical technologies) US Big Pharma is any better at this than European? They all face the same ticking clock once they’ve applied for the patent on a compound, to get it through the clinical trials and regulatory hoops.

    The shambolic state of medical IT in the USA (outside a few islands of excellence like the VA and Mayo) is evidence against your “the US is better at dissemination” theory. I can believe that US technology here is as good as or better than Finland’s, but the lack of coordination creates strong disincentives to bringing it in. Without agreed standards and a clear national roadmap, and given the horrendous learning costs, nobody wants to buy into a potential Betamax.

    The more I look at US health care, the more it reminds me of say the energy use of Soviet industry. It’s such a wasteful mess that making it more efficient should be staggeringly easy. 30% admin costs! God help us. If Obama really were a socialist dictator, he could cut US health costs by several percentage points of GDP and still have universal care at a better average standard than now. Average, not élite. Of course there’s no such plan.

  5. evil is evil says:

    I have severe medical and mental problems. I have to have drugs that are effective. I will not take any medicine unless it has been out 20 years or more and the side effects are fully documented. Big Pharma has a chokehold on americans.

    I live in a third world place in a second world country. They did a “trade” (monopoly) deal with the usa. My cost of american drugs jumped over 100 per cent at legitimate pharmacies. Almost immediately the smugglers, with connections to organizations in countries that do not have a “trade” (monopoly) deal with the usa, started delivering real genuine american made drugs at a level that actually caused the legitimate pharmacies prices to drop 25 per cent below the original price. They had to buy smuggled goods because the smugglers were drowning the market selling drugs that came in by mule.

    Now that is Real Free Trade.

  6. Mark Kleiman says:

    1. Megan McArdle makes mistakes (unlike the rest of the world). As is always the case, mistakes leading to a conclusion one doesn’t like are much more psychologically salient than mistakes leading to conclusions one does like; that’s why smart, well-intentioned liberals can deny the existence of smart, well-intentioned conservatives, and vice versa.

    McArdle seems to have made a serious mistake in this case. But my willingness to cut her slack has little to do with personal ties and much to do with the fact that some of her non-mistaken posts present cogent analysis that I don’t see elsewhere, and the fact that reasonably sane and civil interlocutors on the Right aren’t so easy to find these days. No one could read her work and think that “Jane Galt” is anything but irony; Megan is an epistemic pessimist after the Hayek model rather than a Randite. Of course I think she takes that viewpoint too far, but it’s not an issue to be ignored, and lots of people on our side tend to ignore it.

    2. On the specific question whether a big cut in pharmaceutical revenues in the U.S. would put a big hole in pharmaceutical profits, McArdle and her critics are, in my view, combining to ask the wrong question. In a business where the marginal cost of production is near zero, and where a large fraction of the marginal revenue dollar therefore goes to the bottom line, every major market makes a large contribution to profit. Imagine a world with two markets, U.S. and non-U.S. Assume that the two markets are identical in terms of production cost as a fraction of revenue, and equal in size. To make things concrete, imagine a company with $1B in revenues, half from each market, and which has a marginal cost of production of 50 cents on the dollar and fixed costs of production, marketing, administration, and research and development of $300 million. So this year it will sell $1B worth of drugs and pay out $800M in costs for a net profit of $200M, 20 cents on the dollar.

    Now cut the revenue from either market in half. Now the company takes in $750M rather than $1B, and has marginal production costs totalling $375M rather than $500M. So profits go from $200M to $75M. So losing a quarter of its revenue – half of its revenue from one of its two markets – costs it five-eights of its profits. If either market were to disappear entirely, the company would run at a loss. So it isn’t actually profitable in either market, considered alone; it’s profitable only if it trades in both markets. So the question “What share of pharmaceutical profits come from the U.S.?” is not a question with a meaningful answer, unless you’re willing to allow the sum of the shares to come to more than the total.

    So the concern that squeezing pharmaceutical pricing in the U.S. might substantially reduce the financial incentive for pharma R&D worldwide is not at all far-fetched. James may be right to say that greater governmental involvement in health care does not tend to squeeze pharmaceutical pricing. But Megan is surely right to say that squeezing pharmaceutical revenues might put downward pressure on the rate at which new drugs are developed. I’m with John Holbo in thinking that the right way to fix that problem, if it is a problem, is through direct public investment in, or subsidy to, pharmaceutical R&D; but that’s not the same as denying that it’s a problem.

  7. paul says:

    There’s another big mistake here, namely the use of the term “innovation” to describe most of pharmaceutical R&D.
    1) Some of the most profitable drugs are just new formulations that effectively extend the patent monopoly life of existing blockbusters.
    2) Others are aimed at conditions where perceived morbidity is the result of advertising campaigns (see glaucoma drugs being marketed to people who want lusher eyelashes)
    3) Yet others (see 1) are marginal improvements at best (see the literature on questionable research design and cherrypicking of results) on existing therapies.

    Which would mostly be ethical points about the industry except for the fact that so much of the money spent on bringing drugs to market is spent on Phase III studies, which often involve huge numbers of patients at a cost of tens or hundreds of millions of dollars. Why so many patients and so much money? In large part, I believe, because you need that kind of statistical power to tease tiny improvements over placebo or over current practice into statistical significance. If you have the kind of new drug people usually think of when they hear the word innovation — seriously better effects on the disease, or drastically diminished side effects for the same therapeutic bang — you’re not going to need nearly the statistical power to discern it, and your r&d costs will be substantially lower.

    So the drugs that eat up the R&D money aren’t necessarily the ones we want developed, and the ones we want developed aren’t necessarily going to be squeezed by revenue reductions.

  8. James Wimberley says:

    Response to Mark:
    In your model you have production costs of 50c on the $. This is far too high. 10c would be very generous. In fact, since the revenue is being cut by reductions in price not quantity, it’s the production costs that are fixed, and the marketing costs that are variable. My point is that if you force a reduction in marketing costs by regulation, you raise profits, quite possibly (if we believe GSK’s accounts) enough to compensate for the reduction in prices. The fact that fixed R&D costs are amortised over the global market doesn’t disprove this hypothesis.

  9. Barry says:

    Mark, you comment is a bit, um, lacking in historical context, and analysis:

    1) Megan has been flagged for *repeated* mistakes. On CT alone, there are three threads ripping her a new excretement orifice on healthcare, alone. This is from an alledged MBA from an elite B-School (Chicago, which she used to boads about). She also gets ragged on for problems with numbers (such as pulling them out of, um, ‘nether regions’).

    2) When somebody makes a lot of mistakes, in areas which should be in their area of ability, in a direction which supports their politics, their honesty comes into legitimate question.

    3) My reference to her fiance was that he’s working in an astroturf operation against healthcare reform – ‘astroturf’ is an important word here, because it means ‘fraudulent’. We’ve gotten past the bias and spin zone, in to fraud. Megan seems not to see this, and acts almost perfectly as if she herself was collecting paychecks from such an operation. As an allegedly objective journalist, she seems very unable to investigate things under her nose. Odd, that.

    4) “…and the fact that reasonably sane and civil interlocutors on the Right aren’t so easy to find these days. ” First, that’s a function of the Right’s strategy; it’s not an accident. I’m 49, and it’s freaky just how much of what we see now is a repeat of the lies directed at the Clinton administration, with only the smallest changes needed (sorta like ‘cretionism’=> ‘intelligent design’, to the point where they did search-and-replace hackjobs on creationist texts). Megan only looks polite, because sarcasm and talking down to people (when she has no right to)looks better in contrast to the shieking loons and paid whores of the right.

    As for Megan’s personal attitude, I, and many others, remember her belief about 2×4′s and freedom of speech.

  10. Mark Kleiman says:

    Barry, I’m sorry to see you’re repeating the nasty slander about Megan McArdle’s 2×4′s (as well as using two scatalogical references in a single sentence).

    Back in primary reality – as opposed to Atrios’s fantasies – McArdle never suggested using 2×4′s to suppress “free speech;” she suggested (unwisely in my view) the use of 2×4′s to defend the livelihoods of Korean storekeepers against anarchists who wanted to trash their stores for no particular reason having anything to do with the Koreans.

    I’d suggest that you check your facts, and improve your your manners, before posting here again.

    Here are links to my two posts on the subject, in case anyone wants to check the facts. Note that the first post consists entirely of a critique of what McArdle wrote.

  11. Barry says:

    Mark, I found the original post by ‘Jane Galt’ ( “Diane E. has a link seeming to indicate that the scruffier element of Saturday’s peace rally is planning on demonstrating for peace by, er, wreaking mayhem. Nothing says “Stop the Madness of Western Imperialism” like a white college student from Winnetka opening a can of whup-ass on some Korean vegetable stand!

    So I was chatting about this with a friend of mine, a propos of the fact that everyone I know in New York is a) more frightened than they’ve been since mid-September 2001 and b) madly working on keeping up the who-the-hell-cares-if-I-get-hit-by-a-truck? insouciance that New Yorkers feel is their sole civic obligation. Said friend was, two short years ago, an avowed pacifist and also a little bit to the left of Ho Chi Minh. And do you know what he said? “Bring it on.”

    I can’t be mad at these little dweebs. I’m too busy laughing. And I think some in New York are going to laugh even harder when they try to unleash some civil disobedience, Lenin style, and some New Yorker who understands the horrors of war all too well picks up a two-by-four and teaches them how very effective violence can be when it’s applied in a firm, pre-emptive manner.”

    I disagree with you on this; Megan clearly hated antiwar protesters, and was fantasizing about an excuse to hurt some.

  12. Mark Kleiman says:

    In other words, McArdle didn’t actually express any hostility to “free speech,” as opposed to random destruction of the property of bystanders, but Barry’s mind-reading powers tell him (and tell him “clearly”) about her actual beliefs and intentions, and that justifies his false and defamatory statement.

    All right, then.