Regulation of the Pharmaceutical-Biotechnology Industry

Patricia M. Danzon, Eric L. Keuffel

Chapter in NBER book Economic Regulation and Its Reform: What Have We Learned? (2014), Nancy L. Rose, editor (p. 407 - 484)
Conference held September 9-10, 2005
Published in June 2014 by University of Chicago Press
© 2014 by the National Bureau of Economic Research

Pharmaceuticals and human biologic products (referred to below as "pharmaceuticals") are regulated in virtually all aspects of the product life-cycle: safety, efficacy and manufacturing quality as a condition for market access; promotion; and pricing. The rationale for heavy regulation of pharmaceuticals is not intrinsic natural monopoly, since any market power enjoyed by individual products derives ultimately from government-granted patents. Rather, regulation of market access, manufacturing and promotion arise because product efficacy and safety can be critical to patient health but are not immediately observable. In contrast, price regulation is best understood as a response by public insurers to the fact that insurance makes consumers price insensitive. Although these considerations suggest that regulation of the pharmaceutical industry is potentially welfare enhancing, designing the optimal structure of such regulation is not simple. Market access regulation entails both resource costs and foregone patient benefits in terms of fewer drugs and delay of those that do launch. On the pricing side, regulation should ideally constrain pricing moral hazard while preserving insurance coverage for patients and appropriate incentives for research and development (R&D). Designing regulatory structures that are both theoretically sound and empirically practical remains an important theoretical and policy challenge. This chapter describes the pharmaceutical industry and its regulation across the globe. Empirical evidence on safety, efficacy, pricing, and promotional regulation is described, with particular focus on implications for welfare and innovation. The chapter concludes with lessons learned and areas for future research.

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This paper was revised on February 4, 2016

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