Against Intellectual Monopoly

(GlaxoSmithKline), of about -21 percent, and No. 12 (Eli Lilly)
and No. 13 (Bayer), of about -27 percent. Furthermore, the post-1985
merger wave runs parallel to the emergence of new biotech companies and,
as documented earlier, of a growing number of generic drugs producers.
These two factors have prevented monopolistic concentration in the industry; the combined worldwide market share of the top thirty pharmaceutical
and biotechnology firms is just over 50 percent. The sales of the two largest
ones covered about 15 percent of the global market for drugs in 2004. Relative size and market share are not the sources of monopoly power, if there is
any, in this industry. Furthermore, although the wave of mergers may have
erected substantial barriers for reaching the top, it would be a stretch to
claim that there are substantial barriers to entry into the industry per se. In
every country we have considered there are often hundreds of competing
pharmaceutical firms, and new biomedical startups are appearing and being
financed, especially in the United States, on a monthly basis.25
    A few additional symptoms may help the reader get a better understanding of why, at the end, we reach the diagnosis we do. Sales are growing, fast;
at about 12 percent a year for most of the 1990s, and still now at around 8
percent a year; R&D expenditures during the same period have been rising
only 6 percent. A company such as Novartis (a big R&D player relative
to industry averages) spends about 33 percent of sales on promotion and 19 percent on R&D. The industry average for the ratio of R&D expenditures
to sales seems to be around 16 percent to 17 percent, while according to a
1998 Congressional Budget Office report, the same percentage was approximately 18 percent for American pharmaceuticals in 1994; according to a
2007 PhRMA report it was 19 percent in 2006. The point here is not that
the pharmaceutical companies are spending too little on R&D - no one
has managed (and we doubt anyone could manage) to calculate what the
socially optimal amount of pharmaceutical R&D is. The point here is that
the top thirty representative firm spends about twice as much on promotion
and advertising as it does on R&D; and the top thirty is where private R&D
expenditure is carried out, in the pharmaceutical industry.

    Next, we note that no more than one-third - more likely one-quarter -
of new drug approvals are considered by the FDA to have therapeutic
benefit over existing treatments, implying that, under the most generous
hypotheses, only 25 percent to 30 percent of the total R&D expenditure
goes toward new drugs. The rest, as we will see better in a moment, goes
toward the so-called me-too drugs. Related to this is the more and more
obvious fact that the amount of price discrimination carried out by the top
thirty among North America, Europe, and Japan is dramatically increasing,
with price ratios for identical drugs reaching values as high as two or
three. The designated victims, in this particular scheme, are apparently U.S.
consumers and, to a lesser extent, northern European and Swiss consumers.
At the same time, operating margins in the pharmaceutical industry run
at about 25 percent against 15 percent or less for other consumer goods,
with peaks, for U.S. market-based firms, as high as 35 percent. The U.S.
pharmaceutical industry has been topping the list of the most profitable
sectors in the U.S. economy for almost two decades, never dropping below
third place, an accomplishment unmatched by any other manufacturing
sector. Price discrimination, made possible by monopoly power, does have
its rewards.
    Summing up and moving forward, here are the symptoms of the malaise
we should investigate further.
    • There is innovation, but not as much as one might think there is, given
what we spend.
    • Pharmaceutical innovation seems to cost a lot and marketing new
drugs even more, which makes the final price for consumers very high
and increasing.
    • Some consumers are hurt more than others, even after the worldwide
extension of patent protection.

Where Do Useful Drugs Come From?
    For starters, useful new drugs seem to come in a growing percentage from
small firms, start-ups, and university laboratories. But this is not an indictment of the patent system, as, probably, such small firms and university labs
would not have put in all the efforts they did in coming up with the new
compounds if the