Greg Mankiw's Blog: CBO on Pharma Profits

Greg Mankiw directs us to a new study from the Congressional Budget Office:

Greg Mankiw's Blog: CBO on Pharma Profits: Today, the Congressional Budget Office released a new report on Research and Development in the Pharmaceutical Industry. Here is a brief excerpt about the measured profitability of this industry:

By standard accounting measures, the pharmaceutical industry consistently ranks as one of the most profitable industries in the United States. Those measures, however, treat most R&D outlays as expenditures rather than as investments that add to the value of a firm. Thus, they omit from a firm%u2019s asset base the value of its accumulated stock of knowledge. For R&D-intensive industries, such as pharmaceuticals, that omission can significantly overstate profitability. Adjusted for the value of its R&D assets, the drug industry's actual profitability still appears to be somewhat higher than the average for all U.S. industries, but not two to three times higher, as standard measures of profitability indicate.

The notion that pharmaceutical companies enjoy extraordinary profits is reinforced by the relationship between prices and costs in the drug industry. The industry's high R&D spending and relatively low manufacturing costs create a cost structure similar to that of, for example, the software industry. Both industries have high fixed costs (for research and development) and low variable costs (to put a software application onto a CD-ROM or to produce a bottle of prescription medication). Consequently, prices in those industries are usually much higher than the cost of providing an additional unit of the product, because revenue from sales of the product must ultimately cover those fixed costs...

Greg would say (and I would agree) that high average pharmaceutical company profits are not the thing we should be looking at to determine whether drug prices are too high or too low, or whether we as a society are investing too much or too little in new drugs, or whether we are providing too much or too little in the way of intellectual property protection.

What should we look at? That's a harder question.

But there is one rule of thumb that is, I think, reliable: when (as under the current administration) the laws Congress passes are in large part drafted by the lobbyists of PhRMA, then there is a very strong presumption that the members of PhRMA:

1. Enjoy too much intellectual property protection, and
2. Able to set their prices of drugs too high.

But I have no clue as to whether we are collectively investing too much or too little.