The cost of new drugs

In 2003, Joseph DiMasi, Ronald Hansen, and Henry Grabowski published an important paper in the highly-regarded Journal of Health Economics that estimated that the average cost of developing a new drug was around $805 million dollars. Hal Pawluk at Blog Critics repeats some nonsense from Public Citizen to claim that high research costs for pharmaceuticals are a myth and that this paper in particular is part of a conspiracy of pharmaceutical companies to raise prices. Frankly, the comments of the critics are laughable but not everyone sees the joke so I will explain.

Here is the number one criticism, the "major flaw," in the DiMasi et al. study according to the critics.

1. The $802 million included $400 million that had nothing to do with bringing drugs to market. It was an estimate of how much the drug companies could have made by investing in some other way. This is an imaginary number that the drug companies do not pay.

(See also, Public Citizen who say these are "theoretical costs that drug companies don’t actually incur.")

Firms spend on R&D from the day the development process begins up until the day the drug is approved for marketing which may be a decade or more later. But a dollar spent early in the process could have been earning interest in the bank for years before marketing approval is achieved. Recognizing this, DiMasi et al. calculate the cost of the drug as if all the money had been spent on the day the drug was approved.

Is this unreasonable? Well, suppose you lend me $5000 - how much would you want back in a year, in 2 years, in 10 years? The longer the loan period the more you would expect back when the loan came due, right? This is exactly the same calculation performed by DiMasi et al.

I challenge anyone who thinks this is imaginary money to lend me $5000. I guarantee to repay them the same return as they recognize as legitimate for the pharmaceutical companies.