Health Care, Technological Change, and Altruistic Consumption Externalities

Traditional economic analysis has proposed well known remedies to deal with consumption externalities and inefficient technological change in isolation, but lacks a general framework for addressing them jointly. We argue that the joint determination of R&D and consumption externalities is central to health care industries around the world generally, and for the pharmaceutical industry in particular. This is because technological change drives the expansion of the health care sector and altruism seems to motivate many public subsidies such as Medicaid in the US. We stress that standard remedies to the two problems in isolation are inefficient — Pigouvian corrections to consumption externalities are inefficient under technological change and standard R&D stimuli are inefficient because they focus only on consumer and producer surplus, not the altruistic surplus accruing to non-consumers. We provide illustrative calculations of the dynamic inefficiency in the level of US R&D spending due to the inability of innovators to appropriate the altruistic surplus. We find that altruistic gains amount to about a quarter of consumer surplus in the baseline scenario. Our analysis implies that total R&D could be under-provided by as much as 60 percent.

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This paper was revised on April 20, 2009

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