October 2004
What Happened to the European Pharmaceutical Industry?
Two decades ago, European firms dominated the world pharmaceutical market, just as they had for most of the twentieth century. Now, with a few notable exceptions, the market is dominated by American firms. U.S.-based companies account for most of the worldwide bestselling drugs and for most newly introduced breakthrough drugs--especially drugs employing biotechnology methods. Drawing on research performed for the European Commission and others, Professor Fabio Pammolli of the University of Florence described the nature and causes of this momentous shift, and two AEI scholars who have worked extensively on pharmaceutical markets, international trade, and high-technology research discussed his work at an October 7 AEI conference.
Fabio Pammolli
University of Florence, Italy
Over the last few decades, the pharmaceutical industry has largely shifted its locus from Europe to the United States. The factors contributing to the European industry's decline, however, have not all been related to the competitiveness of European firms. The molecular biology revolution that began in the 1970s changed the landscape of drug development. Despite the expanded scientific opportunities, the output of European firms declined, challenging the public-private business model in places throughout Europe. Some have called for an industry restructuring that rejects market-based models in favor of public initiatives, but that solution is wrong.
Another factor that has shaped pharmaceutical innovation is the patent system. Some critics claim that patents stifle innovation and call for their abolition altogether. That debate was internationalized by the TRIPs agreement, when pharmaceuticals entered the terrain of foreign policy. Patents became linked to developing countries' health status even when patents had no effect on their access to medicines.
As medical spending increases with innovation, budget constraints exert pressure on the market. Even in the United States, the Medicare Modernization Act of 2003 moved the U.S. health care system closer to state control. Budget pressures and the visibility of differential pricing across nations have also fueled an intense reimportation debate. At present, Europe can cut its prices and rely on the United States for pharmaceutical innovation. The expansion of the European Union will only exacerbate this problem, as even cheaper pharmaceuticals from accession countries drive down EU prices further. European reliance on U.S. research and development (R&D) will become even greater, strengthening calls for reimportation in the United States.
In a 2000 report for the European Commission, my colleagues and I examined the decline of the European pharmaceutical industry and evaluated the structural determinants. In a current update to that report, we investigate the structural indicators shaping the industry today. Despite the growth of the U.S. pharmaceutical industry, the EU remains a net exporter of pharmaceutical products to the United States. Also, Europe's pharmaceutical sector remains vigorous within Europe, ranking fifth largest among manufacturing sectors. Pharmaceutical sector employment, on the other hand, has declined as a share of manufacturing employment.
In the United States, value added (VA) per pharmaceutical sector employee is higher and faster growing than in Europe. In fact, Europe's VA per employee is declining, even as it increases in the United States, creating a remarkable disparity between the two.
U.S. firms lead in terms of sales of new chemical entities, though their advantage over Europe has decreased in recent years. The United States has consolidated its role as a locus of pharmaceutical R&D, as it has achieved an effective division of labor among public research organizations (PROs), biotechnology companies, and big pharmaceutical manufacturers. Finally, the U.S. market is more competitive, exhibiting greater generic penetration and market share turnover.
The accession of Eastern European countries to the EU may induce some interesting shifts in Europe's pharmaceutical industry. Labor costs in Hungary and the Slovak Republic, for example, are far lower than the current EU average. With a solid scientific base already in place, Eastern Europe may attract the few R&D labs remaining in Europe. This transition within Europe, however, is unlikely to affect Europe's competitiveness with the United States and Japan.
Investment in pharmaceutical R&D has increased in all major countries, but the United States ranks first in R&D spending and ratio of R&D to production. Also, the United States most effectively attracts research activities, especially in biotechnology. The distribution of U.S. patents by location of inventors shows the United States having a tremendous lead, again, particularly in biotechnology. Another metric for the geographical spread of pharmaceutical R&D is the share of U.S. patent citations--a loose proxy for the quality of patents. The U.S. advantage is even more pronounced here, suggesting that the quality of research done in the United States is far better.
Across public research organizations, biotechnology firms, and big pharmaceutical companies, the United States leads the world in projects originated and developed. More importantly, however, it has built huge internal networks that collaborate effectively on R&D. Public research organizations in the United States are far more innovative than their counterparts abroad. Even European governments partner with American biotechnology and pharmaceutical firms for R&D initiatives.
Networks of public institutions conducting pharmaceutical R&D can be mapped using patent coassignments, which reflect collaboration among PROs (see Figure 1). The distances between the various institutions represent the closeness of those relationships. The clusters of research organizations are all located in the United States--Boston and the west coast, for example. The National Institutes of Health serves as an integrator of R&D conducted across the United States, particularly at academic institutions. There is no equivalent in Europe, where labor markets are fragmented, and European universities are absent from R&D networks.
Figure 1. Institutional Networking in Biomedical Innovation
Cooperation among research institutions in the United States has emerged from vigorous competition. Regrettably, the European Commission's response to this picture was for Brussels to mandate new relationships among European PROs.
The European Commission constructs its budget projections for welfare policy, which includes spending on health care and on medical technology, like new drugs. In the Commission's budget models, the primary constraints are demographic, while medical technology is largely absent. Where the budget projections incorporate technology, the projections assume that new technology will yield budget savings in the future. In fact, new technology has traditionally raised total costs, so its absence from cost projections could prove extremely problematic for welfare policy based on these forecasts.
The regulatory and competitive structures in the United States and Europe have produced very different markets for pharmaceuticals. Charting the 2003 growth rates of new pharmaceutical products in Italy, we analyzed the likely impact of two regulatory measures considered by the Italian government--drug price caps and reductions in patent length. In Figure 2, the outermost "tent" (a dotted line) represents the predicted growth or decline of various products in the absence of the cost-cutting measures. Products to the left of the zero point would decline, while products on the right would grow. The innermost "tent" (a solid line) represents predicted product growth trends if the cost-cutting measures are adopted. In this less competitive environment, there would be fewer winners and fewer losers (represented by the fact that the solid line moves relatively little from the initial zero point). Under such an arrangement, the turnover in the Italian market would also have been less.
Figure 2. Regulation, Competition, and Innovation
Before the measures were considered, products that were growing were generally American products, whereas the declining products were by and large Italian. The price caps and patent reductions would therefore have had a discriminatory effect against U.S. products, although they were conceived as neutral, across-the-board measures. These policies were ultimately rejected when their dampening effect on Italian R&D and bias against American products were understood.
The pharmaceutical innovation that follows certain scientific advances can be tracked to understand how R&D works. When one enzymatic pathway was revealed a decade ago, pharmaceutical companies from all over the world began to pursue that line of research. By 2000, several parallel research efforts were underway. It may be tempting to label the resulting products "me-too's" or copycats of the initial breakthrough, but they are the result of ongoing competition driven by science.
Claude E. Barfield
AEI
The decline of the European pharmaceutical industry has been shaped by a complex intersection of factors--policy, industrial structure, competition, and many factors independent of policy. There are not even ten obvious determinants of the shift, so priorities are hard to gauge.
Professor Pammolli's work lends great support to our patent system. In the long run, the informational quality of patents counterbalances any deterrent effects claimed by critics. Our patent system, buttressed by healthy capital markets, has encouraged the boom of our biotechnology industry. Pharmaceutical R&D has also flourished in the United States because our research system is so flexible and fluid. Scientists are free to move between public labs, academic institutions, and pharmaceutical companies. R&D funding is centrally coordinated by the National Institutes of Health, but NIH has never been involved in development.
John E. Calfee
AEI
It is obvious that no one could ever have invented an R&D system like the United States has today. It may not be perfect, but Europe's experience suggests that our system is indeed working. The work by Pammolli and his colleagues has provided remarkable empirical insights into the divergence between American and European experience. Clearly, Europe faces difficult challenges in restoring its pharmaceutical industry.
AEI research assistant Ximena Pinell prepared this summary.
