Wednesday, December 08, 2004

The truth about "The Truth About the Drug Companies"

I recently did some in-store-browsing of the recent book The Truth About the Drug Companies: How They Deceive Us and What to Do About It by Marcia Angell, who is, among other things, the former editor-in-chief of the New England Journal of Medicine. It's really a dreadful book. Angell certainly knows more about medicine and drug research than I do, and there is probably some truth behind most of the problems she cites. (For example, I'll admit I don't quite understand why financial statements from the pharmaceutical firms show them spending twice as much on administration and marketing as they do on research.) But her book is not just about technology, it's about markets and investment decisions. And Angell clearly doesn't understand markets, and doesn't even seem to try.

For example, she echoes other critics in decrying the fact that the drug companies' profits as a share of revenues are higher than in most other sectors. But she doesn't even seem to consider the question of what should determine reasonable profit levels. It is quite natural that different sectors will have different accounting profit levels (as a share of revenues) in order to achieve the same real return on investment. In particular, sectors that rely heavily on long term investments that do not pay off for several years will need higher accounting profits, especially if these investments are financed through equity. Can anyone think of an sector like that? I can...

(Some people attempt to justify high profits as a compensation for the high risk inherent in drug development. But most of this risk is probably diversifiable, and therefore should not command a risk premium. One possible exception might be the risk that government might impose onerous new regulations or price controls, a risk that is actually worsened by people like Angell!)

Angell's main target is the phenomenon of "me-too" drugs. In fact, her number one policy recommendation is that new drugs would have to be proven more effective than existing drugs to get approved. Her complete lack of any attention to any of the possible downsides of such a policy is typical. (If this research about Celebrex holds up, it will provide one convenient counterargument.)

For a much more interesting and thoughtful take on "me-too" drugs, Alex Tabarrok is doing a series of posts on the subject at Marginal Revolution. Tabarrok and others also question whether we should even have any effectiveness requirement for new drugs...after all, we don't require effectiveness to be shown for off-label uses, and most doctors believe that this benefits patients.


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