Analysis Finds Meaningful Impact on Pharmaceutical Innovation From Reduced Revenues

The announcement of new drugs for Medicare price negotiation brought renewed attention on a key point of contention: Does lowering drug prices harm future innovation? While there is a lot of research in this area, it hasn’t been summarized effectively and estimates vary widely.

A new white paper from the USC Schaeffer Center for Health Policy & Economics sheds light on this issue. The authors find that for every 10% reduction in expected U.S. revenues, pharmaceutical innovation—such as clinical trial starts or new drug approvals—is expected to ultimately fall by 2.5% to 15%.

“The effects of reduced revenue on pharmaceutical innovation could be quite significant, even at the lower end,” says Darius Lakdawalla, chief scientific officer at the Schaeffer Center. “The question becomes: Do the short-run benefits of lowering drug prices outweigh the long-term risks of foregoing innovation and the longer, better lives that come from it.”

Pharmaceutical firms adjust their research and development programs in response to market factors and policy changes that may impact current and expected future revenues. This influences drug-development decisions and, ultimately, the flow of new drugs. For example, the introduction of Medicare Part D expanded the market by greatly increasing coverage of prescription drugs, while the Inflation Reduction Act’s Medicare drug price negotiation program—which will subject a growing number of brand name drugs to a price ceiling—shrinks the market.

The Schaeffer Center estimate is based on a critical review of past studies measuring the impact of reduced revenues on pharmaceutical innovation. This review included the model used by the nonpartisan Congressional Budget Office to forecast the innovation impacts of Medicare’s drug price negotiation program.

“Elasticity” of innovation—or the degree to which changes in revenue affect innovation—is not a fixed measure. It varies based on numerous factors, such as drug pricing policies and market dynamics, making it difficult to project precise impacts on future drug development.

“It’s firmly established that companies cut back on research when pharmaceutical revenues fall,” says Schaeffer Center Co-Director Dana Goldman. “The challenge is to determine what this means future population health. Given the contributions of drugs to better health—GLP-1s are a notable example—this suggests we should be cautious in our demands for lower prices.”

Key takeaways from the paper include:

1. The study examines the “elasticity” of innovation, which measures how responsive innovation (e.g., the number of Phase 1 trials or new drug approvals) is to a change in expected or actual revenues.
2. Economic evidence demonstrates this elasticity is positive—meaning lower revenues lead to less R&D—but estimates vary widely.
3. The long-run innovation elasticity associated with U.S. revenues lies between 0.25 and 1.5, implying that a 10% reduction in expected revenues leads to a 2.5% to 15% decline in pharmaceutical innovation.
4. The magnitude of this elasticity likely depends on the time horizon studied, the size of the price change, cost of drug development, barriers to value-based pricing, and other marketplace factors.

Other authors are Darren Filson of Claremont McKenna College and Karen Van Nuys of the Schaeffer Center. This white paper was funded by the USC Schaeffer Center, which is supported by funding from a wide variety of public and private institutions and donors, including the pharmaceutical industry. A complete list of our funders can be found in our annual report.