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OCR for page 363
Pharmaceuticals and Biotechnology1
IAIN COCKBURN
University of British Columbia and
National Bureau of Economic Research
REBECCA HENDERSON
Massachusetts Institute of Technology and
National Bureau of Economic Research
LUIGI ORSENIGO
Universita Commerciale Luigi Bocconi
GARY P. PISANO
Harvard Business School
The pharmaceutical industry has been by almost any measure outstandingly
successful. It is one of the few high-technology industries that American firms
have dominated almost since its inception, and it is one of the few in which
American firms continue to have an indisputable lead. During the 1980s and
1990s, double-digit rates of growth in earnings and return on equity were the
norm for most pharmaceutical companies, and the industry as a whole ranked
among the most profitable in the United States.2
To what degree can this success be viewed as a triumph of U.S. public policy?
This question cannot be answered definitively because the roots of the industry's
success are complex, and causality cannot be attributed to any single factor with
precision. A plausible case can be made, however, that in the case of the pharma-
ceutical industry public policy has played a particularly important role in contrib-
uting to the global success of American firms.
Public policy has always played an enormously important role in shaping the
pharmaceutical industry in the United States. On the supply side, public funding
for health-related research supplies both new knowledge and highly trained em-
ployees to pharmaceutical firms. New drugs can be sold only with the explicit
~ This paper draws on an ongoing program of work exploring the determinants of research produc-
tivity in the pharmaceutical industry, funded by the Program on the Pharmaceutical Industry and the
Center for Innovation in New Product Development under NSF Cooperative Agreement Number
EEC-9529140. Their support is gratefully acknowledged.
2 Note that these figures are based on accounting rates of return. Figures that are recalculated to
account for heavy spending by the industry on advertising and research suggest that rates of return
were actually somewhat lower than the accounting figures would suggest.
363
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U.S. INDUSTRYIN2000
approval of the federal government, an approval that is typically granted only
after potential candidates have passed a series of rigorous clinical tests. On the
demand side, the federal government has an enormous impact on the market for
new drugs, both by virtue of its role as a major consumer of drugs through its
funding of Medicare and Medicaid and through its regulation of how pharmaceu-
tical firms may advertise and market their products. Public policy toward the
protection of intellectual property also has a very significant effect because the
pharmaceutical industry is one of the few in which intellectual property protec-
tion plays a central role in product market competition. Public policy also plays
a more indirect but nevertheless important role in shaping the industry through its
effects on both the labor markets and the markets for new capital, particularly the
market for venture capital.
Taken together these policy instruments have been instrumental in building
an exceptionally strong industry. Before World War II public policy played little
role in shaping the industry's evolution. In the postwar period, however, the
federal government's heavy investment in basic research, its support of a strong
intellectual property regime, and its imposition in 1962 of tight product approval
criteria combined to help create an industry whose leading firms were not only
increasingly able to translate scientific advances into effective therapies but also
well positioned to exploit the new opportunities opened up by the revolution in
molecular biology.
The molecular biology revolution made the role of public policy in shaping
the industry even more important. The revolution was initially based in the uni-
versities, and the size and strength of the American commitment to health-related
research ensured that U.S. universities were at the frontier of the new science. But
public policy also proved very important in shaping the ways in which the new
science affected the pharmaceutical industry. The industry used molecular biol-
ogy in two forms as a new process technology in making large molecular weight
drugs and as a new research tool in searching for more conventional, small mo-
lecular weight drugs. The vast majority of drugs prescribed today are "small"
molecular weight drugs relatively small, simple molecules that can be synthe-
sized in a test tube and that often can be taken orally. "Large" molecular weight
drugs, are much, much larger. They usually cannot be directly synthesized but
must be "grown" or "expressed" and cannot usually be taken orally.
The first trajectory was, at least initially, unambiguously competence de-
stroying and was most effectively exploited by new entrants. In the United States
an institutional environment that not only supported universities in making the
fundamental breakthroughs necessary to exploit the new science but also sup-
ported their translation into small, flexible, aggressively funded new firms led to
the birth of an entire industry segment, the biotechnology firms.
At the same time the second trajectory the adoption of the tools of biotech-
nology as search tools proved to be competence destroying for those pharma-
ceutical firms that had not fully made the transition to "science-based" or "ratio
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PHARMACEUTICALS AND BIOTECHNOLOGY
365
nal" drug discovery. It thus reinforced the dominance of the large scientifically
based firms, a large majority of which were located in the United States and
which owed much of their success to the U.S. public policy regimes of the 1970s
and 1980s.
The remainder of this chapter expands on this argument. We begin by dis-
cussing the evolution of drug discovery research technology and the role of pub-
lic policy in shaping U.S. success prior to the molecular biology revolution. We
suggest that a number of public policies played instrumental roles in building an
American industry that was among the strongest in the world. The third section
lays the foundation for a discussion of the impact of public policy on the industry
in the wake of the revolution in molecular biology. We suggest that molecular
biology as a process technology "biotechnology" was competence destroying
for the vast majority of established firms, while molecular biology used as a
research tool was competence enhancing for those firms that had already made a
transition to science driven, or more "rational" drug discovery. Further, we
describe the ways in which the revolution shaped the evolution of the industry
across the world, focusing particularly on the ways in which response in the U.S.
was very different, and in many ways much more effective, than responses in
Europe and Japan. Finally, we discuss the role of public policy in shaping this
differential response. We suggest (as have many before us) that public policy
was instrumental in laying the foundations for the explosion of vibrant "new
biotechnology firms" that characterized the American response to "biotechnol-
ogy." We also suggest that the ability of many of the established American firms
to respond effectively to the challenges of the new science was predicated on
skills that they had developed during the previous era, skills developed partly in
response to an environment largely shaped by American public policy.
THE PHARMACEUTICAL INDUSTRY BEFORE THE
MOLECULAR BIOLOGY REVOLUTION
The history of the pharmaceutical industry can be usefully divided into three
major epochs. The first, corresponding roughly to the period 1850-1945, was one
in which little new drug development occurred and in which the minimal research
that was conducted was based on relatively primitive methods. The large-scale
development of penicillin during World War II marked the emergence of the
second period of the industry's evolution. This period was characterized by the
institution of formalized in-house R&D programs and relatively rapid rates of
new drug introduction. During the early part of the period the industry relied
largely on so-called "random" screening as a method for finding new drugs, but
in the 1970s the industry began a transition to "guided" drug discovery or "drug
development by design," a research methodology that drew heavily on advances
in molecular biochemistry, pharmacology, and enzymology. The third epoch of
the industry had its roots in the 1970s but did not begin to flower until quite
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U.S. INDUSTRYIN2000
recently as the use of the tools of genetic engineering in the production and dis-
covery of new drugs has come to be more widely dispersed.
Understanding the evolution of the industry in the first two periods is impor-
tant because their history illustrates the role public policy played in shaping the
industry and because both the industrial and institutional structure of the industry
and the organizational capabilities of individual firms were molded during these
early periods.
Early History
By almost any measure pharmaceuticals is a classic high-technology or
science-based, industry. Yet drugs are as old as antiquity. For example, the
Ebers Papyrus lists 811 prescriptions used in Egypt in 550 B.C. Eighteenth cen-
tury France and Germany had pharmacies where pharmacists working in well-
equipped laboratories produced therapeutic ingredients of known identity and
purity on a small scale. Mass production of drugs dates back to 1813, when J.B.
Trommsdof opened the first specialized pharmaceutical plant in Germany. Dur-
ing the first half of the nineteenth century, however, standardized medicines for
treating specific conditions were virtually nonexistent. A patient instead would
be given a customized prescription that would be formulated at the local phar-
macy by hand.
The birth of the modern pharmaceutical industry can be traced to the mid-
nineteenth century with the emergence of Germany and Switzerland as leaders of
the new synthetic dye industry. This was due in part to the strength of German
universities in organic chemistry and in part to Basel's proximity to the leading
silk and textile regions of Germany and France. During the 1880s dyestuffs and
other organic chemicals were discovered to have medicinal effects, such as
antiception. It was thus initially Swiss and German chemical companies such as
Ciba and Sandoz, Bayer and Hoescht, leveraging their technical competencies in
organic chemistry and dyestuffs, that began to manufacture drugs, usually based
on synthetic dyes, later in the nineteenth century. For example, the German com-
pany Bayer was the first to produce salicylic acid (aspirin) in 1883.
Mass production of pharmaceuticals also began in the United States and the
United Kingdom in the later part of the nineteenth century, but the pattern of
development was quite different from that of Germany and Switzerland. Whereas
Swiss and German pharmaceutical activities tended to emerge within larger
chemical-producing enterprises, the United States and the United Kingdom wit-
nessed the birth of specialized pharmaceutical producers such as Wyeth (later
American Home Products), Eli Lilly, Pfizer, Warner-Lambert, and Burroughs-
Wellcome. Up until World War I German companies dominated the industry,
producing approximately 80 percent of the world's pharmaceutical output.
In the early years the pharmaceutical industry was not tightly linked to for-
mal science. Until the 1930s, when sulfonamide was discovered, drug companies
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PHARMACEUTICALS AND BIOTECHNOLOGY
367
undertook little formal research. Most new drugs were based on existing organic
chemicals or were derived from natural sources such as herbs, and little formal
testing was done to ensure either safety or efficacy. Harold Clymer, who joined
SmithKline in 1939, noted:
[Y]ou can judge the magnitude of [SmithKline's] R&D at that time by the fact I
was told I would have to consider the position temporary since they had already
hired two people within the previous year for their laboratory and were not sure
that the business would warrant the continued expenditure.
World War II and wartime needs for antibiotics marked the drug industry's
transition to an it&D-intensive business. Alexander Fleming discovered penicil-
lin and its antibiotic properties in 1928. Throughout the 1930s, however, it was
produced only in laboratory-scale quantities and was used almost exclusively for
experimental purposes. With the outbreak of World War II, the U.S. government
organized a massive research and production effort that focused on commercial
production techniques and chemical structure analysis. More than 20 companies,
several universities, and the Department of Agriculture took part. Pfizer, which
had production experience in fermentation, developed a deep-tank fermentation
process for producing large quantities of penicillin. This system led to major
gains in productivity and, more important, laid out an architecture for the process
and created a framework in which future improvements could took place.
The commercialization of penicillin marked a watershed in the industry's
development. Due partially to the technical experience and organizational capa-
bilities accumulated through the intense wartime effort to develop penicillin, as
well as to the recognition that drug development could be highly profitable, phar-
maceutical companies embarked on a period of massive investment in R&D and
built large-scale internal R&D capabilities. At the same time there was a very
significant shift in the institutional structure surrounding the industry. Whereas
before the war public support for health-related research had been quite modest,
after the war it boomed to unprecedented levels, helping to set the stage for a
period of great prosperity.
Golden Age for the Industry: 1950-1990
The period from 1950 to 1990 was a golden age for the pharmaceutical in-
dustry, as the industry in general, and particularly the major U.S. players, firms
such as Merck, Eli Lilly, Bristol-Myers, and Pfizer, grew rapidly and profitably.
R&D spending literally exploded and with them came a steady flow of new drugs.
Drug innovation was a highly profitable activity during most of this period.
Statman (1983), for example, estimated that accounting rates of return on new
drugs introduced between 1954 and 1978 averaged 20.9 percent (compared to a
cost of capital of 10.7 percent). Between 1982 and 1992, firms in the industry
grew at an average annual rate of 18 percent.
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U.S. INDUSTRYIN2000
Several factors supported the industry's high average level of innovation and
economic performance. One was the sheer magnitude of both the research oppor-
tunities and the unmet needs. In the early postwar years, there were many physi-
cal ailments and diseases for which no drugs existed. In every major therapeutic
category, from pain killers and anti-inflammatories to cardiovascular and central
nervous system products, pharmaceutical companies faced an almost completely
open field. Before the discovery of penicillin, very few drugs effectively cured
diseases.
Faced with such a "target-rich" environment but very little detailed knowl-
edge of the biological underpinnings of specific diseases, pharmaceutical compa-
nies invented an approach to research now referred to as "random screening."
Under this approach, natural and chemically derived compounds are randomly
screened in test tube experiments and laboratory animals for potential therapeutic
activity. Pharmaceutical companies maintained enormous "libraries" of chemi-
cal compounds and added to their collections by searching for new compounds in
places such as swamps, streams, and soil samples. Thousands, if not tens of
thousands, of compounds might be subjected to multiple screens before research-
ers honed in on a promising substance. Serendipity played a key role because the
"mechanism of action" of most drugs, the specific biochemical and molecular
pathways that were responsible for their therapeutic effect, was generally not
well understood. Typically, researchers had to rely on the use of animal models
as screens. For example, researchers injected compounds into hypertensive rats
or dogs to explore the degree to which they reduced blood pressure. Under this
regime it was not uncommon for companies to discover a drug to treat one dis-
ease while searching for a treatment for another.
Although random screening may seem inefficient, it worked extremely well
for many years and continues to be widely employed. Several hundred chemical
entities were introduced in the 1950s and 1960s, and several important classes of
drug were discovered in this way, including a number of important diuretics, all
of the early vasodilators, and several centrally acting agents, including reserpine
and guanethidine.
In the early 1970s, the industry also began to benefit more directly from the
explosion in public funding for health-related research that followed the war.
Between 1970 and 1995, for example, support for the National Institutes of Health
(NIH), the agency through which the vast majority of federal support for health-
related research is channeled, increased nearly 200 percent in real terms, to over
$8.8 billion a year or 36 percent of the federal nondefense research budget, an
amount roughly equal to the total research expenditure of all the U.S. pharmaceu-
tical firms (Figure 1~.
Before the 1970s publicly funded research was probably most important to
the industry as a source of knowledge about the etiology of disease. From the
middle 1970s on, however, substantial advances in physiology, pharmacology,
enzymology, and cell biology the vast majority stemming from publicly funded
OCR for page 369
PHARMACEUTICALS AND BIOTECHNOLOGY
10.00
8.00
6.00
4.00
2.00
0.00
369
Nominal I Deflated
-
-
~_ ~' ~' T ~
1970 1975 1980 1985 1990 1995
Year
FIGURE 1 NIH total appropriations (billions of dollars).
research led to enormous progress in understanding the mechanism of action of
some existing drugs and the biochemical and molecular roots of many diseases.
This new knowledge made it possible to design significantly more sophisticated
screens. By 1972, for example, the structure of the renin angiotensive cascade,
one of the systems within the body responsible for the regulation of blood pres-
sure, had been clarified by publicly funded researchers, and by 1975 several com-
panies had drawn on this research in designing screens for hypertensive drugs
(Henderson and Cockburn, 1994~. These firms could replace ranks of hyperten-
sive rats with precisely defined chemical reactions. Instead of requesting "some-
thing that will lower blood pressure in rats," pharmacologists could request
"something that inhibits the action of the angiotensin 2 converting enzyme."
In turn, the more sensitive screens made it possible to screen a wider range of
compounds. Before the late 1970s, for example, it was difficult to screen the
natural products of fermentation, a potent source of new antibiotics, in whole
animal models. The compounds were available in such small quantities or trig-
gered such complex mixtures of reactions in living animals that it was difficult to
evaluate their effectiveness. The use of enzyme systems as screens made it much
easier to evaluate these kinds of compounds. It also triggered a "virtuous cycle"
in that the availability of drugs whose mechanisms of action were well known
made possible significant advances in the medical understanding of the natural
history of several key diseases, advances that in turn opened up new targets and
opportunities for drug therapy (Gambardella, 1995; Maxwell and Eckhardt,1990~.
The industry's increasing reliance on advances in fundamental science dra-
matically increased the importance of public sector research in shaping industry
productivity. Publicly funded research was important for several reasons. First,
it provided the "raw knowledge" that undergirded many key discoveries. Table 1
illustrates the increasingly close relationship between the public and private sec-
tors during the period. It summarizes detailed case histories of the discovery and
development of 21 drugs identified by two leading industry experts as "having
had the most impact upon therapeutic practice" between 1965 and 1992. Only 5
OCR for page 370
370
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OCR for page 371
PHARMACEUTICALS AND BIOTECHNOLOGY
371
of these drugs, or 24 percent, were developed with essentially no input from the
public sector. These data suggest that public sector research has become more
important to the private sector over time.
Table 1 groups the drugs into three classes according to the research strategy
by which they were discovered: those discovered by "random screening," those
discovered by "mechanism-based screening," and those discovered through fun-
damental scientific advances. Broadly speaking, the degree of reliance on the
public sector for the initial insight increases across the three groups, and as the
industry has moved to a greater reliance on the second and third approaches, so
too has the role of the public sector increased. The public sector was also impor-
tant in providing highly trained employees for the private sector and in helping to
sustain a "research ethos" within those private firms that aggressively embraced
the new techniques and that was highly productive.
Efforts to measure the rate of return to public research have been very con-
tentious and dogged by a variety of difficult practical and conceptual problems
(Griliches, 1994; Ward and Dranove, 1995~. However in a recent study Cockburn
and Henderson (1998) suggest that differences in the effectiveness with which
pharmaceutical firms access the upstream pool of knowledge created by public
science correspond to differences in research productivity of as much as 30 per-
cent. Zucker et al. (forthcoming) find very similar results in their study of the
role of the public sector in supporting the growth of the newly founded biotech-
nology firms.
Although any estimate of this type must be treated with great caution, these
results are consistent with the hypothesis that public sector research has been
critically important to the industry's health. Most intriguingly from a public
policy perspective, these authors found that a firm's connectedness to the public
sector, measured by the coauthorship of scientific papers across institutional
boundaries, is closely related to several other factors that enhance the productiv-
ity of privately funded pharmaceutical research. These include the number of
"star scientists" employed by the firm and the degree to which the firm uses a
researcher' s reputation among his or her peers as a criterion for promotion.3 These
results are consistent with the hypothesis that the ability to take advantage of
knowledge generated in the public sector requires investment in a complex set of
activities that taken together change the nature of private sector research. Thus
they raise the possibility that the ways in which public research is conducted may
be as important as the level of public funding.
Despite their apparent importance, these new research techniques were not
uniformly adopted across the industry. For any particular firm, the shift in the
technology of drug research from "random screening" to one of "guided" discov-
ery or "drug discovery by design" depended critically on the ability to take ad
3 The use of coauthoring behavior to measure connectedness to the public sector was pioneered by
Zucker et al. (1997) in their study of the emergence of new biotechnology firms.
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U.S. INDUSTRYIN2000
vantage of publicly generated knowledge (Cockburn and Henderson, 1996;
Gambardella, 1995) and of economies of scope within the firm (Henderson and
Cockburn, 1996~. Smaller firms, those farther from the centers of public re-
search, and those that were most successful with the older techniques of rational
drug discovery appear to have been much slower to adopt the new techniques
than were their rivals (Cockburn et al.,1998; Gambardella, 1995; Henderson and
Cockburn, 1994~. There was also significant geographical variation in adoption.
The larger firms in the United States, the United Kingdom, and Switzerland were
among the pioneers of the new technology, but Japanese and other European
firms have been slow in responding to the opportunities afforded by the new
science. In general, although the pharmaceutical industry is global in nature,
companies from the United States, Switzerland, Germany, and the United King-
dom have dominated in the postwar period. French and Italian firms have not
played major international roles. Japan is the second largest pharmaceutical mar-
ket in the world and is dominated by local firms, largely for regulatory reasons;
but Japanese firms have to date been conspicuously absent from the global indus-
try. Only Takeda ranks among the top 20 pharmaceutical firms in the world, and
until relatively recently the innovative performance of Japanese pharmaceutical
firms has been weak compared with their U.S. and European competitors.
INSTITUTIONAL ENVIRONMENTS
Institutional forces have shaped the industry in the "pre-biotechnology
world," providing powerful inducements to innovation. From its inception, the
evolution of the pharmaceutical industry has been tightly linked to the structure
of national institutions. The pharmaceutical industry emerged in Switzerland and
Germany in part, because of strong university research and training in the rel-
evant scientific areas. German universities in the nineteenth century were leaders
in organic chemistry, and Basel, the center of the Swiss pharmaceutical industry,
was the home of the country's oldest university, long a center for medicinal and
chemical study. In the United States the government's massive wartime invest-
ment in the development of penicillin profoundly altered the evolution of Ameri-
can industry. In the postwar era, the institutional arrangements in four key areas,
the public support of basic research, intellectual property protection, procedures
for product testing and approval, and pricing and reimbursement policies, have
strongly influenced both the process of innovation directly and the economic
returns, and thus the incentives, for undertaking such innovation.
Public Support for Health-Related Research
Nearly every government in the developed world supports publicly funded
health-related research, but countries vary significantly in both the level of sup-
port offered and in the ways in which it is spent. As reviewed earlier, public
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PHARMACEUTICALS AND BIOTECHNOLOGY
373
spending on health-related research in the United States is now the second larg-
est item in the federal research budget after defense and is roughly equivalent to
the research budget of the entire U.S. pharmaceutical industry. Both qualitative
and quantitative evidence suggests that this spending has had a significant effect
on the productivity of those large U.S. firms that were able to take advantage of
it (Cockburn and Henderson, 1998; Maxwell and Eckhardt, 1990; Ward and
Dranove, 1995~.
Public funding of biomedical research also increased dramatically in Europe
in the postwar period, although the United Kingdom spent considerably less than
Germany or France, and total spending did not approach American levels (Table
2~. Moreover, the institutional structure of biomedical research in continental
Europe evolved quite differently from its evolution in the United States and the
United Kingdom, creating an environment in which science is far less integrated
with medical practice.
Science does not in general confer the same status within the medical profes-
sion in continental Europe as it does in the United Kingdom or the United States.
Traditionally the medical profession has had less scientific preparation than is
common in either the United States or the United Kingdom, and medical training
and practice have focused less on scientific methods per se than on the ability to
use the results of research. Moreover doctorates in the relevant scientific disci-
plines have been far less professionally oriented. Historically the incentives to
engage in patient care at the expense of research have been very high. France and
TABLE 2 Breakdown of National Expenditures on Academic and Related
Research by Main Field, 1987a
Expenditure (1987 million dollars)
U.K. FRG France Netherlands U.S. Japan Averageb
Engineering 436 505 359 112 1966 809 14.3%
15.6% 12.5% 11.2% 11.7% 13.2% 21.6%
Physical sciences 565 1015 955 208 2325 543 21.2%
20.2% 25.1% 29.7% 21.7% 15.6% 14.5%
Life sciences 864 1483 1116 313 7285 1261 36.3%
30.9% 36.7% 34.7% 32.7% 48.9% 33.7%
Social sciences 187 210 146 99 754 145 6.0%
6.7% 5.2% 4.6% 10.4% 5.1% 3.9%
Arts and humanities 184 251 218 83 411 358 6.8%
6.6% 6.2% 6.8% 8.6% 2.8% 9.6%
Other 562 573 418 143 2163 620 15.6%
20.1% 14.2% 13.0% 14.9% 14.5% 16.6%
Total 2,798 4,037 3,212 958 14,904 3,736
Expenditure data are based on OECD "purchasing power parities" for 1987 calculated in early 1989.
bThis represents an unweighted average for the six countries (i.e., national figures have not been
weighted to take into account the differing size of countries).
Source: Irvine et al. (1990, p. 219).
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U.S. INDUSTRYIN2000
NATIONAL SYSTEMS OF INNOVATION:
HOW DID PUBLIC POLICY MATTER?
This brief description of the impact of the revolution in molecular biology on
the pharmaceutical industry highlights the diversity of responses across the world
and suggests several "stylized facts" to be explored in examining the relationship
between "national systems of innovation," or the entire set of public policies and
institutional constraints that shaped the evolution of any particular firm and the
evolution of the industry across the world. First, why was the use of molecular
biology as a production tool pioneered in the United States by small, newly
founded firms, in Japan by firms diversifying into the industry from other fields,
and in Europe largely by established pharmaceutical firms? Why did new en-
trants play a much smaller role in the European context? Second, did national
systems of innovation play a role in shaping the diffusion of the use of molecular
biology as a research tool? This technology was pioneered by established phar-
maceutical firms in almost every case, yet its rate of adoption varied widely across
the world.
The Evolution of "Biotechnology"
Why the small, independently funded biotechnology start-up was initially an
American phenomenon is an old question and a much discussed one. One of the
reasons that it cannot be answered definitively is that the answer is to a large
degree overdetermined; many factors were clearly at play, almost any one of
which may have been sufficient. As the discussion has already suggested, the use
of molecular biology as a production technology was a competence-destroying
innovation for the vast majority of the established pharmaceutical firms. In the
United States a combination of factors allowed small, newly founded firms to
take advantage of the opportunity this created. These factors included a favorable
financial climate, strong intellectual property protection, a scientific and medical
establishment that could supplement the necessarily limited competencies of the
new firms, a regulatory climate that did not restrict genetic experimentation, and,
perhaps most importantly, a combination of a very strong local scientific base and
academic norms that permitted the rapid translation of academic results into com-
petitive enterprises. In Europe, apart from the United Kingdom, and in Japan
many of these factors were not in place, and it was left to larger firms to exploit
the new technology.
A Strong Scientific Base and Academic Norms
The majority of the American biotechnology start-ups were tightly linked to
university departments, and the very strong state of American academic molecu-
lar biology clearly played an important role in facilitating the wave of start-ups
that characterized the 1 980s (Zucker et al. forthcoming). The strength of the local
science base may also be responsible within Europe for the relative British ad
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PHARMACEUTICALS AND BIOTECHNOLOGY
389
vantage and the relative German and French delay. Similarly, the weakness of
Japanese industry may partially reflect the weakness of Japanese science. There
seems to be little question about the superiority of the American and British sci-
entific systems in the field of molecular biology, and it is tempting to suggest that
the strength of the local science base explains much of the regional differences in
the speed with which molecular biology was exploited as a tool for the production
of large molecular weight drugs.
Although this explanation might seem unsatisfying to the degree that aca-
demic science is rapidly published and thus, in principle, rapidly available across
the world, the American lead appears to have been particularly important because
the exploitation of biotechnology in the early years required the mastery of a
considerable body of tacit knowledge that could not be easily acquired from the
literature (Zucker et al., 1997; Pisano, 1996~. Geographic proximity probability
facilitated the transmission of this kind of tacit knowledge (Jaffe et al., 1993~. In
the case of biotechnology, however, several authors have suggested that the U.S.
start-ups were not simply the result of geographic proximity (Zucker et al., 1997~.
These authors have suggested that the flexibility of the American academic sys-
tem, the high mobility characteristic of the scientific labor market, and, in gen-
eral, the social, institutional, and legal context that made it relatively straightfor-
ward for leading academic scientists to become deeply involved with commercial
firms were also major factors in the health of the new industry.
The willingness to exploit the results of academic research commercially
also distinguishes the U.S. environment from that in either Europe or Japan. This
willingness has been strengthened since the late 1970s and the passage of the
Bayh-Dole Act (see below), and the resulting role of universities as seedbeds of
entrepreneurship has probably also been extremely important in the take-off the
biotechnology industry.
In contrast, links between the academy and industry, especially the relatively
free exchange of personnel, appear to have been much weaker in Europe and
Japan. Indeed, the efforts of several European governments were targeted pre-
cisely toward strengthening industry-university collaboration, and it has been ar-
gued that the rigidities of the research system of continental Europe and the large
role played in France and Germany by the public, nonacademic institutions have
significantly hindered the development of biotechnology in those countries. That
these kinds of factors, as distinct from the strength of the science base per se,
were absolutely critical to the wave of new entry in biotechnology that occurred
in America in the early 1980s is given further credibility by the rate at which the
use of molecular biology diffused across the world.
Access to Capital
It is commonly believed that lack of venture capital restricted the start-up
activity of biotechnology firms outside the United States. Clearly, venture capi
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U.S. INDUSTRYIN2000
tat, a largely American institution, played an enormous role in fueling the growth
of the new biotechnology-based firms. Prospective start-ups in Europe, however,
appear to have had many other sources of funds, usually through government
programs. The results of several surveys also suggest that financial constraints
did not constitute a significant obstacle for the founding of new biotechnology
firms in Europe (Ernst and Young, 1995; MERIT, 1996; SERD, 1996~.
In addition, although venture capital played a critical role in the founding of
U.S. biotechnology firms, collaborations between the new firms and the larger,
more established firms provided a potentially even more important source of capi-
tal. Why did prospective European or Japanese biotechnology start-ups not turn
to established pharmaceutical firms as a source of capital? A plausible explana-
tion focuses on the market for know-how in biotechnology. The evolution of that
market created many opportunities for European and Japanese companies to col-
laborate with U.S. biotechnology firms. Although some U.S.-based new firms,
such as Amgen, Biogen, Chiron, Genentech, and Genzyme, pursued a strategy of
vertical integration from research through marketing in the U.S. market, most
firms' strategies emphasized licensing product rights outside the U.S. to foreign
partners. Thus to an even greater extent than many established U.S. pharmaceu-
tical firms, European and Japanese firms were well positioned as partners for
U.S. new biotechnology firms. Given the plethora of new U.S. firms in search of
capital, European and Japanese firms interested in commercializing biotechnol-
ogy had little incentive to invest in local biotechnology firms. Even in the ab-
sence of other institutional barriers to entrepreneurial ventures, start-ups in Eu-
rope or Japan might have been crowded out by the large number of U.S.-based
firms anxious to trade non-U.S. marketing rights for capital.
Intellectual Property Rights
The establishment of clearly defined property rights also played a major role
in making possible the explosion of new firm foundings in the United States,
because the new firms, by definition, had few complementary assets that would
have enabled them to appropriate returns from the new science in the absence of
strong patent rights (Teece, 1986~.
In the early years of biotechnology, considerable confusion surrounded the
conditions under which patents could be obtained. In the first place, research in
genetic engineering was on the borderline between basic and applied science.
Much of it was conducted in universities or otherwise publicly funded, and the
degree to which it was appropriate to patent the results of such research became
the subject of bitter debate. Millstein and Kohler's groundbreaking discovery,
hybridoma technology, was never patented, while Stanford University filed a
patent for Boyer and Cohen's process in 1974. Boyer and Cohen renounced their
own rights to the patent, but nevertheless they were strongly criticized for having
being instrumental in patenting what many observers considered to be a basic
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PHARMACEUTICALS AND BIOTECHNOLOGY
391
technology. Similarly a growing tension emerged between publishing research
results versus patenting them. The norms of the scientific community and the
search for professional recognition had long stressed rapid publication, but patent
laws prohibited the granting of a patent to an already published discovery (Merton,
1973; Kenney, 1986~. In the second place the law surrounding the possibility of
patenting life-formats and procedures relating to the modification of life-forms
was not defined. This issue involved a variety of problems, but it essentially
boiled down, first, to whether living things could be patented at all and, second, to
the scope of the claims that could be granted to such a patent (Merges and Nelson,
1994).
These hurdles were gradually overcome. In 1980 Congress passed the Patent
and Trademark Amendments of 1980 (Public Law 96-517~. Also known as the
Bayh-Dole Act, this law gave universities, and other nonprofit institutions and
small businesses, the right to retain the property rights to inventions deriving
from federally funded research. In 1984 Congress expanded the rights of univer-
sities further, by removing certain restrictions contained in Bayh-Dole regarding
the kinds of inventions that universities could own and the right of universities to
assign their property rights to other parties. In 1980 the U.S. Supreme Court
ruled in favor of granting patent protection to living things (Diamond v.
Chakrabarty); the case involved a scientist working for General Electric who had
induced genetic modifications on a Pseudomonas bacterium that enhanced its
ability to break down oil. In the same year the second reformulation of the Cohen
and Boyer patent for the recombinant DNA process was approved. In subsequent
years, a number of patents were granted establishing the right for very broad
claims (Merges and Nelson, 1994~. Finally, a one-year grace period was intro-
duced for filing a patent after publication of the invention.
It is often stressed that the lack of adequate patent protection was a major
obstacle to the development of the biotechnology industry in Europe.8 First, the
grace period available in the United States is not available in Europe; any discov-
ery that has been published is not patentable. Second, the interpretation has pre-
vailed that naturally occurring entities, whether cloned or uncloned, cannot be
patented. As a consequence, the scope for broad claims on patents is greatly
reduced, and usually process rather than product patents are granted. In 1994 the
European Parliament rejected a draft directive from the European Commission
that attempted to strengthen the protection offered to biotechnology.
Although it is clear that stronger intellectual property protection is not unam-
biguously advantageous, as the controversy surrounding NIH's decision to seek
patents for human gene sequences clearly illustrated, in the early days of the
industry, the United States probably reaped an advantage from its relatively
stronger regime.
~ See, for instance, Ernst and Young (1995).
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392
Regulatory Climate
U.S. INDUSTRYIN2000
Although public opposition to genetic engineering was a significant phe-
nomenon in the United States in the earliest years of the industry, it has quickly
become less important, and in general the regulatory climate has been a favorable
one (Kenney, 19861. In Europe, however, opposition to genetic engineering re-
search by the "Green" parties is often cited as an important factor hindering the
development of biotechnology, especially in Germany and other Northern Euro-
pean countries, and public opposition to biotechnology is said to have been a
factor behind the decision of some European companies to establish research
laboratories in the United States.
The Use of Molecular Biology as a Research Tool
Explaining variations in the rate of adoption of molecular biology as a re-
search tool across the regions of the world is, in contrast, rather more difficult. In
general the techniques were adopted first by the large, globally oriented U.S.,
British, and Swiss firms. Adoption by the other European firms, and by the
Japanese, appears to have been a much slower process.
At first glance the relative strength of the local science base and the degree to
which university research was connected to the industrial community appears to
be as important an explanation here as it was in understanding the case of the
diffusion of "biotechnology." Science in Japan and mainland Europe was argu-
ably not as advanced as it was in the United States and Britain, a factor that
slowed the adoption of the new techniques. Unfortunately this explanation is
made much less plausible by the Swiss case. The Swiss companies established
strong connections with the U.S. scientific system, suggesting that geographic
proximity played a much less important role in the diffusion of molecular biology
as a research tool.
A second possible explanation is that diffusion was shaped by the relative
size and structure of the various national pharmaceutical industries. Henderson
and Cockburn (1996) have shown that between 1960 and 1990 there were signifi-
cant returns to size in pharmaceutical research, and that since 1975 these returns
have come primarily from the exploitation of economies of scope. They interpret
this finding as suggesting that the effective adoption of the techniques of guided
search and more rational drug design placed a premium on the ability to integrate
knowledge within the firm and thus that the larger, more experienced firms may
have been at a significant advantage in the exploitation of the new techniques. To
the degree that those firms that had already adopted the techniques of "rational"
drug discovery were at a significant advantage in adopting molecular biology as a
research tool, the pre-existence of a strong national pharmaceutical industry with
some large internationalized companies may have been a fundamental prerequi-
site for the rapid adoption of molecular biology as a tool for product screening
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PHARMACEUTICALS AND BIOTECHNOLOGY
393
and design. The U.S. pharmaceutical industry has traditionally been internation-
ally oriented and, at least since the early 1980s, open to international competition
in the domestic market. But in many European countries, such as France and
Italy, the pharmaceutical industry was highly fragmented into relatively small
companies engaged essentially in the marketing of licensed products and in the
development of minor products for the domestic markets.
Although size or global reach may have been a necessary condition, the fail-
ure of the largest German and Japanese firms to adopt these techniques suggests
that it was not sufficient. The largest Japanese and German firms were arguably
as international and as large as the Swiss.
The most plausible explanation is that institutional variables, particularly the
stringency of the regulatory environment and the nature of patent regime, were
also important. As mentioned earlier, there is now widespread recognition that
the introduction of the Kefauver-Harris Amendments had a significant impact in
inducing a deep transformation of the U.S. pharmaceutical industry, particularly
through raising the cost and complexity of R&D. Partly as a result many U.S.
firms were forced to upgrade their scientific capability.
Similarly the two European countries, the United Kingdom and Switzerland,
whose leading firms did move more rapidly to adopt the new techniques appear to
have actively encouraged a "harsher" competitive environment. The British sys-
tem encouraged the entry of highly skilled foreign pharmaceutical firms, espe-
cially the American and the Swiss, and a stringent regulatory environment also
facilitated a more rapid trend toward the adoption by British companies of institu-
tional practices typical of the American and Swiss companies in particular,
product strategies based on high-priced patented molecules, strong links with
universities, and aggressive marketing strategies focused on local doctors. The
resulting change in the competitive environment in the home market induced
British firms to pursue strategies that moved away from fragmenting innovative
efforts into numerous minor products toward concentration on a few important
products that could diffuse widely into the global market. By the 1970s the ensu-
ing transformations of British firms had led to their increasing expansion into the
world markets.
Lacy Glenn Thomas (1994) has suggested that the slowness with which the
majority of the European firms, apart from British and Swiss firms, adopted the
techniques of guided drug discovery reflected much weaker competitive pres-
sures in their domestic markets. The Japanese experience also looks in many
respects like that pursued in Europe outside Switzerland and the United King-
dom. In Japan legal and regulatory policies combined to frame a very "soft"
competitive environment that appears to have seriously slowed the adoption of
modern techniques by the Japanese pharmaceutical industry. As a result of the
combination of patent laws, the policies surrounding drug licensing, and the drug
reimbursement regime, Japanese pharmaceutical firms had little incentive to de-
velop world-class product development capabilities, and in general they concen
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U.S. INDUSTRYIN2000
bated on finding novel processes for making existing foreign or domestically
originated molecules (Mitchell et al., 1995~. Moreover, Japanese firms were pro-
tected from foreign competition and simultaneously had strong incentives to li-
cense products that had been approved overseas. Under this regime the predomi-
nant technology strategy for Japanese pharmaceutical companies became the
identification of promising foreign products to license.
Mitchell et al. (1995) have noted that some of these institutional factors are
beginning to change and that these changes are starting to have effects on the
R&D strategies and capabilities of some but not all firms participating in the
Japanese pharmaceutical sector. After 1967 foreign-originated products required
clinical testing in Japan before they could be approved for sale. After 1976 drug
products could be patented. After 1981 pricing policy was changed so that prices
for established drugs are reviewed periodically and compared with prices of newer
drugs. Together these factors have combined to increase the incentives for origi-
nal research. Recent evidence suggests that the share of new chemical entities
approved in the United States that originate in Japan has increased substantially,
from 4 percent in the 1970s to around 25 percent in 1988 (Mitchell et al., 1995~.
Nevertheless, because they lack a history of strong internal R&D, it is taking time
for Japanese pharmaceutical companies to develop world class research capabili-
ties.
Strong domestic competition, the existence of appropriate incentive mecha-
nisms toward aggressive R&D strategies, and integration into the world markets
thus appear to be important explanatory variables in analyzing variations in the
diffusion of the new technologies in drug screening and design across regions.
Note, however, that they appear to say little about variations in diffusion across
Arms.
Most of the firms that rapidly adopted the new techniques were large multi-
national or global companies, with a strong presence, at least as far research is
concerned, in the United States and generally on the international markets. Zucker
and Darby (1997) present some evidence that size alone is a reasonable predictor
of adoption, at least in the United States. We suspect that this correlation reflects
the fact that adoption is highly correlated with the degree to which firms have
made the transition to guided drug discovery. By and large these were larger
firms that had early developed a taste for science and that were able to build and
sustain tight links to the public research community (Gambardella, 1995~. Here
institutional factors appear to have been a necessary but not sufficient condition.
To the extent that the adoption of the new techniques also involved the successful
adoption of particular, academic-like forms of organization of research within
companies (Henderson, 1994), and this process was in turn influenced by the
proximity and availability of first-rate scientific research in universities, it was
much easier for American and to a lesser extent British firms to adopt them.
From this perspective, it is tempting to suggest that the origin of the Ameri-
can advantage in the use of biotechnology as a research tool as well as a process
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PHARMACEUTICALS AND BIOTECHNOLOGY
395
technique lies in the comparatively closer integration between industry and the
academic community, compared with other countries. One might also speculate
that this closer integration resulted in some degree from the strong scientific base
of the American medical culture and from the adoption of tight scientific proce-
dures in clinical trials. Through this mechanism, American companies might
have come to develop earlier and stronger relationships with the biomedical com-
munity and with molecular biologists in particular. Segregation of the research
system from both medical practice and from close contact with commercial firms
(as in France and possibly in Germany) has been highlighted as a major factor
hindering the transition to molecular biology in these two countries (see, for in-
stance, Thomas, 1994~.
CONCLUSION
Public policy plays a crucial role in shaping private sector productivity in
many modern economies. The case of the pharmaceutical industry provides a
particularly intriguing window into this process and into the importance of na-
tional systems of innovation in shaping industrial structure (Nelson, 1992~.
Before the revolution in molecular biology, the U.S. pharmaceutical industry
was shaped by public policy choices in a number of areas. Strong support for the
life sciences provided both highly trained employees and a steady stream of
knowledge that was a critical input to the industry. A tough regulatory environ-
ment and an intellectual property regime together increased the returns to funda-
mental innovation and further combined to create a cohort of large, diversified,
highly skilled firms able to manage the transition from random to science-guided
discovery effectively.
The revolution in molecular biology further reinforced the power of public
policy in shaping the industry. In the first place, the revolution's extraordinary
dependence on fundamental science meant that the large commitment the United
States made to public funding became even more important. But the importance
of public policy extends far beyond the simple provision of funding for research.
In the case of biotechnology, or the use of molecular biology as a production
technique, advances in basic science rendered obsolete several of the core com-
petencies of existing firms, particularly those related to process development and
manufacturing. In the United States, institutional flexibility on a wide range of
dimensions led to the formation of specialized biotechnology firms that could
provide these competencies and bridge the gap between basic university research,
on the one hand, and clinical development of drugs on the other. Thus the new
biotechnology-based firms were, in many ways, an institutional, or public policy-
shaped, response to the technical opportunities created by new scientific know-
how.
The case of biotechnology as a research tool presents a different but comple-
mentary picture. This trajectory was born within the confines of established phar
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U.S. INDUSTRYIN2000
maceutical firms, and institutional factors appear to played a "necessary" rather
than "sufficient" role in its diffusion. Pharmaceutical firms adopted biotechnol-
ogy as a research tool as a way to use molecular biology to enhance the value and
productivity of their existing assets and competencies, and in this sense biotech-
nology tools were "competence enhancing." But they were only competence
enhancing for some pharmaceutical firms those that were already oriented to-
ward "high science" research and already firmly embedded in the global scien-
tific community. Thus this case is one of existing institutional arrangements and
structures shaping, rather than creating, the path of technical change. Forces
facilitating institutional flexibility and responsiveness played a less prominent
role in this domain, which may help to explain why Swiss and British firms have
joined U.S. firms as leaders in the application of molecular biology to small mol-
ecule discovery.
We hesitate to draw any hard and fast conclusions about how public policy
might best be shaped in the future to support the health of the industry. But this
brief historical overview does raise several intriguing questions. First, it high-
lights the extraordinarily important role of publicly funded science in supporting
the industry. Most important from a policy perspective, perhaps, it highlights the
fact that the ways in which this research is conducted may be as important as the
level to which it is funded. The published results of publicly funded research are,
with some lag, widely diffused across the world, and this kind of "output" clearly
had an important impact on the industry. But our discussion suggests American
industry was able to gain extraordinary benefits from this research because of the
fluid nature of the boundary between public and private research institutions in
the field. In the case of the larger, more established firms, this led to the creation
of several exceptionally creative and flexible research organizations that were
heavily influenced by the norms of "open" science. In the case of biotechnology,
it led to the foundation of an extraordinary number of new firms whose energy
and creativity has been the envy of the world. To the extent that efforts to realize
a direct return on public investments in research lead to a weakening of the cul-
ture and incentives of "open science," our results are consistent with the hypoth-
esis that the productivity of the whole system of biomedical research may suffer.
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Representative terms from entire chapter:
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