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Summary in. The U.S. pharmaceutical industry has for decades been one of the m ost profitable and rapidly growing sectors of the American economy. Its continuing expansions of output, productivity, and jobs have been achieved alongside price increases that have been more moderate than the general rate of inflation. Together with other high-technology industries, it has played an important role in generating exports and net trade surpluses. Additionally, new pharmaceuticals have made significant contributions to improved health and to the control of escalating medical costs. On the basis of these achievements, the pharmaceutical industry has maintained an image of immunity from the deterio- ration of competitive position besetting many sectors of the American economy, such as automobiles, steel, textiles, an d consumer electronics. Unfortunately, this image is apparently exaggerated, and probably false. Data compiled by this study indicate a clear relative deterioration in the foundation of phar- maceutical competitive position--the research efforts necessary for discovery and introduction of new patented drugs. Persistence of the image of unchallenged American preemi- nence in pharmaceuticals would appear to be based on two rather unique features of the industry. In the first place, the time lapse between strategic decisions by ethical drug firms and the impact of these decisions on the market is particularly long. The most critical of these decisions involves investments in discovery of new patentable drugs, yet basic pharmaceutical research per- formed today may well not produce marketed products within this century, and even drugs now being synthesized will on average not be introduced into the United States until the mid-1990s. As a consequence, deteriorations now occurring in the relative inno- vative abilities of American pharmaceutical firms will not be visible in product markets for several years and not fully felt for as long as two decades. 1

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2 A second factor masking the relative decline of U.S. firms is the inherent potential for growth in the pharmaceutical industry. This is a time of major advances in the basic sciences of human health, developments that have opened up significant possibilities for new drug products and associated sales growth. Given this progress in basic sciences, U.S. pharmaceutical firms will almost inevitably be, and in fact are, innovative, growing, and profitable. The performance of the U.S. ethical drug industry is thus quite different from those less fortunate sectors of the U.S. economy that have been damaged by escalating energy prices or that are threatened by low-wage competition from developing nations. Comparisons among different sectors of the U.S. economy, how- ever, are not useful for evaluation of the performance either of corporate management or national industrial policy, precisely because the underlying potential for growth or decline in a particular industry is in large measure uncontrollable. Far more relevant comparisons may be made among U.S. and foreign firms within the same industry, all of which have access to similar t echnological opportunities. From this perspective of relative U.S.-foreign competitive performance, a declining U.S. share of a growing industry is as much a concern for U.S. industrial policy as a declining share of an industry undergoing retrenchment. Not every reduction in the U.S. market share of an industry, of course, is indicative of managerial or public policy failures. FOF example, the almost economy-wide loss of U.S. shares of major markets to Europe during the 1950s represented the recovery of those war-damaged economies to normal levels of output rather than any faltering of American economic achievement. Likewise, the gradual diffusion overseas of production by those industries that extensively use unskilled labor has been interpreted as the basic consequence of free trade and represents efficient realloca- tion of resources. This report does not address the question of an appropriate U.S. share of the world pharmaceutical industry. Nonetheless, several circumstances--the traditional importance of U.S. firms within this industry, the excellence of American research in basic biomedical sciences, the enormous expenditures of the U.S. government to fund this basic research, and the gen- eral importance of high-technology industries for the U.S. trade balanc - - ll suggest that the relative decline in U.S. pharmaceu- tical competitive position should be cause for further inquiry, if not concern. FINDINGS ON THE U.S. COMPETITIVE POSITION Because 14 or more years can separate the synthesis of new ethical drugs and the ultimate marketing of these substances,

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3 available data at various stages in the pharmaceutical develop- ment process allow the examination of the expected evolution of competitive position over the near-term future. The foundation of national pharmaceutical competitive advantage lies in successful innovation. Thus current research efforts provide a forecast of future sales, earnings, and jobs in the industry. By examining different segments of the innovation proces-from RHO expen- diture, to drugs entering clinical trials, to marketed drugs, to sales and market structure for new drugs--the existing and expected future competitive patterns may be simultaneously compared. The basic findings on the U.S. position at various stages of the pharmaceutical innovation process are summarized below an d discussed in detail in the second chapter of the report. . The U.S. share of world pharmaceutical RED expenditures has fallen from greater than 60 percent during the 1950s to less than 30 percent in 1982. Else number of new drugs entering U.S. clinical trials and owned by U.S. firms has steadily dropped from a yearly average of 60 in the mid-1960s to about 25 per year in 1982. In contrast, the number of foreign-owned drugs undergoing comparable trials has remained almost constant at about 20 per year. The U.S.-owned share of new drug introductions has remained roughly stable in most major markets, with generally a 60 percent share of U.S. introductions and a 22 percent share of worldwide introductions. Th e percentage of world pharmaceutical production occurring in the United States has fallen from 50 percent in 1962, to 38 percent in 1968, to 27 percent in 1978. The share of pharmaceutical sales by U.S.-owned firms fell slightly in major markets during the 1960s and has been roughly constant since. In our domestic market, the share of U.S. firms was 87 percent in 1965 and 80 percent in 1982. Smaller U.S. pharmaceutical firms self-originate fewer new drugs than before 1960 and are increasingly dependent on foreign firms for licensed new products, though licensed products still account for less than half of drug introductions by small firms. During the 1970s, European pharmaceutical firms established a broad multinational base in the (J.S. domestic market that will in the near future be used for direct marketing of European pharmaceutical innovation. The U.S. share of world pharmaceutical exports has fallen from greater than 30 percent before 1960 to less than 15 percent today.

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4 An overview of these trends indicates a marked drop for the U.S. presence in world pharmaceutical markets around 196 0, followed by stability in the U.S. share of new drug introductions and sales (outputs of the innovative process). In contrast, the U.S. share of R&D expenditures and drugs entering clinical trials (inputs of the innovative process) has continued to decline, strongly suggesting an eventual further decline in U.S. shares of introductions, sales, and exports. DETERMINANTS OF NATIONAL PHARMACEUTICAL COMPETITIVE ADVANTAGE Sources of these trends in competitive postion can be segregated into two categoric - -those factors that generally affect the entire U.S. economy and those factors that have unique impact on the pharmaceutical industry. Numerous studies have documented an almost economy-wide deterioration in competitive position for American firms against their foreign counterparts. As is di s- cussed in the third chapter of this report, many of the declines in U.S. pharmaceutical competitive position listed above can be attributed to whatever factors have led to the relatively poorer performance of the U.S. economy in the aggregate. Two aspects of pharmaceutical competitive position, however, are atypical from the general U.S. industrial experience. The first unique feature has been the precipitous drop in the proportion of world drug production located within U.S. boundaries, a decline wholly unmatched in other segments of the chemical industry. Foreign non-tariff trade barriers such as discriminatory safety regulations and pricings by public health authorities are apparently the predominant cause of this divergent trend. Second and even more significant for the future economic strength of U.S. ethical drug firms, the steady decline in the American share of world pharmaceutical R&D efforts is markedly more severe than com- parable changes in world RED shares for other U.S. industries. Again, factors specific to the ethical drug industry should be invoked to explain this distinctive performance. Factors that have contributed to this important trend are (in no particular order): Foreign non-tariff trade barriers, mentioned above. U.S. Food and Drug Administration (FDA) regulations, imposing significant costs and delays on the research efforts of U.S. firms. Patent laws, differing among developed nations in the extent of market protection provided to innovators. In this regard, U.S. patent policy is more restrictive than that of certain nations, but more generous than that of some others.

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Li ability regimes for consumer product claims that are more cumbersome and risky in the United States than in certain competitor nations. Antitrust policies that may prevent attainment of economies of scale in pharmaceutical research through mergers among U.S. firms. Tax incentives for conduct of research. Determination of the specific relative importance of each factor is beyond the scope of this study. The basic conclusion to be drawn, however, remains that the overall balance of several (possibly conflicting) government policies provides a relatively more favorable environment abroad for pharmaceutical research. Careful evaluation of these and other government policies with the goal of encouraging innovation is needed. OPTIONS FOR AMERICAN POLICY The study identifies a variety of policy options to counteract the causes of decline in the competitive position of the United States pharmaceutical firms. Trade Options FDA policy prohibiting the export of unapproved new drugs, and thus requiring United States companies to manufacture these products abroad, should be revised by regulation to permit the export of pharmaceutical chemicals for such use. The prevalence of foreign trade barriers that favor domestic products over American drugs should be investigated to determine an appropriate United States response. Domestic Economic Options Le. gislation should be enacted to restore the amount of patent time lost as a result of FDA regulatory requirements. Antitrust policy should be reconsidered to determine whether it discourages mergers that would make U.S. pharmaceutical companies more effective competitors on a worldwide scale. Research tax credits should be expanded to include research-related expenditures not now eligible for the investment tax credit. Research and develop- ment expenditures incurred in the United States should be allo- cated solely to the United States income of the taxpayer. The

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6 impact of product liability on the pharmaceutical industry should be studied in an attempt to reduce this disincentive to research. Regulatory Options The recommendations of the recent report of the Commission on the Federal Drug Approval Process should be implemented by FDA through administrative changes in current regulations as rapidly as possible. Adoption of these recommendations would expedite the IND and NDA review process, thus reducing the size of the investment needed to develop new pharmaceutical products and increasing the return on such investment. Improvements in the drug approval process can be made without any reduction in public health protection and can be expected to result in more rapid availability of important new drugs to combat serious diseases for which effective drugs are not currently available.