I. Introduction

My name is James Love. I work for the Center for Study of Responsive Law, where I am Director of Economic Studies and also the Director of the Taxpayer Assets Project (TAP), a group created by Ralph Nader to monitor the management and sale of government property, including intellectual property rights from government funded research. Beginning in 1991, TAP has undertaken a number of studies of the federal government's role in funding research and development for pharmaceutical drugs. I have presented testimony or comments on this subject to the U.S. Congress on several occasions, and I have written articles for public policy, trade and general interest publications. Prior to joining the Center for Study of Responsive Law I was senior economist for the Frank Russell Company, a large pension funding consulting firm, and I have held teaching and research positions at Princeton University, Rutgers University, and the National Bureau of Economic Research.

We are pleased that NIH is holding a second forum to solicit advice and recommendations from the public on the agency's use of Cooperative Research and Development Agreements (CRADAs). The first forum, held on July 21, 1994, was principally a forum for pharmaceutical and biotechnology companies to register objections to the NIH model reasonable pricing clause, which is included in some NIH CRADAs. One presumes, based upon the published notice and Draft Mandate, that this second forum is designed to provide additional balance to the comments provided by the industry at the July 21 forum.

II. The Timing and Notice of the Second CRADA FORUM

The Draft Mandate says that the NIH Director is asking for recommendations from "primarily consumers and other public interest groups." However, the presentations and advice received today will necessarily be limited, because the notice for the meeting was issued in late August, during peak vacation time, and the forum is being held three days after labor day. Because of the short timetable, consumers and public interest organizations have not been given an adequate opportunity to prepare for this meeting.

We ask that NIH give the public an additional 60 days to prepare comments on this important topic.

III. The Framing of the Issue

While the Draft Mandate for this Second CRADA forum says that the meeting will be "solely on 'reasonable pricing'", the organization of the three "issues" and panels are largely framed in the terms emphasized by the industry, which wants to eliminate the reasonable pricing clause, and persuade NIH officials to consider negotiated royalties or simply the availability of the drug as only public interest returns on the public's investments.

The first panel at the September 8th forum is asked if the public investment in R&D is "adequately reflected through the payment of royalties and the expeditious development of new products," or if NIH should be "involved in 'downstream' issues of marketing and distribution, such as the pricing of such products?" The second panel appears to be asked what types of royalty payments should be negotiated with the industry. Only the third panel focuses entirely on the reasonable pricing clause, and then only with a highly selective set of questions which focus on the potential conflicts between reasonable pricing and product development -- a trade-off which does not exist at all for some government funded drugs.

NIH could have organized the forum much differently, and indeed, if NIH had bothered to work closer with its critics, it would have avoided the appearance of yet another one-sided assault on the reasonable pricing clause. For example, the three panels could have been asked to consider such questions as:

• If a firm obtains rights to an invention developed principally with public funds, should the company be free to charge consumers what ever the market will bear, without limit?

• What can be done to prevent the public from paying twice for drug development, first as taxpayers, and then as consumers?

• Should the government routinely collect information on the economics of drug development and marketing, for those drugs developed with significant public support? For example, should the government obtain information on the annual sales revenue, manufacturing costs and marketing costs for ddI or Taxol?

• For those drugs which are developed with significant public support, how much of the sales revenue is obtained from patients who are insured by the government, through medicaid, medicare, the military or other programs?

• How should the public's investment in drug development be valued, when compared to the industry's investments? For example, should the government's investments be adjusted for risk, inflation and the time value of money, similar to the methodology typically used to reckon the private sector's costs of drug development?

• Was the methodology used by NIH to evaluate the "reasonableness" of the price of ddI or Taxol a good one? (Under this methodology, a drug such as levamisole could be increased in price by more than 1,700 percent and still be considered reasonably priced.)

• Should NIH use the median prices of drugs used for similar therapeutic purposes as a benchmark for a reasonable price? What if 95 percent of the cost of the drug's development was paid for by the taxpayers?

If NIH framed the reasonable pricing issue with questions such as these, the discussions would likely focus on constructive changes in the administration of the reasonable pricing clause, rather than a debate over whether or not to eliminate the clause.

IV. Why is the NIH Reasonable Pricing Clause Important?

Industry's heated opposition to the NIH reasonable pricing clause must seem like a mystery to some observers. On the one hand, the pharmaceutical industry is making extravagant assertions that the government's role in new drug development is extremely minor compared to that of private industry, and yet at the same time industry groups are becoming increasingly strident over the grave dangers of NIH reasonable pricing agreements for NIH research projects which involve NIH funded staff or contractors. If the government's role is as minor as we are constantly being told by the industry, then why is there so much industry concern about a fair pricing clause that only applies when the government is directly involved in the research?

Indeed, the NIH reasonable pricing clause, which has only been used in NIH CRADAs and patent licenses, does not apply to the more than $7 billion per year in grants and contracts to Universities and other institutions who obtain patent rights under the Bayh-Dole Act.

Why then is the NIH reasonably pricing clause so important? The answer is two fold. First, the one fifth of the NIH research budget which is spent on intramural research is a substantial amount of money that is highly productive in terms of new drug development. The new drugs which are developed with direct NIH involvement are important in terms of their efficacy, innovation and the severity of the illnesses which they treat. Unfortunately, because of the innovative nature of the drugs and the severity of the illnesses, companies know that it is possible to charge very high prices, as indicated by the prices of new drugs such as Ceredase, which costs some patients more than $500,000 for a year of treatment. Since a single new drug can generate billions of dollars in revenue, even if it has a tiny population of users, companies want to preserve as much pricing flexibility as possible.

Secondly, the existence of any reasonable pricing mechanisms creates a model which may someday be applied in broader applications. Apparently the current Congress isn't prepared to regulate drug prices, but if the "roll out" prices of drugs continue to soar and the cost of drugs becomes an increasingly important component of the nation's health care bill, there may be efforts to limit marketing exclusivity under the Orphan Drug Act, exercise government march-in rights under the Bayh-Dole Act, or apply price controls across the board when drugs are priced excessively. Before such actions are likely, the government will have to confront the thorny issue of a reasonable pricing methodology. The existence of a methodology for determining the reasonableness of a drug's price is thus perceived to be an important step toward broader efforts to reduce drug prices.

V. Will reasonable pricing mechanisms reduce industry investments in pharmaceutical R&D?

The pharmaceutical industry has raised the specter of huge reductions in industry R&D efforts if the government engages in any attempts to regulate drug prices, including those drugs developed with government support. This is an important question, which deserves thoughtful analysis. Of course, if all variables are held constant, except that drug prices are reduced, there will be a negative impact on private sector new drug R&D of some unknown magnitude. But, this simplistic scenario is not appropriate for several reasons.

1. The need for efficient R&D incentives.

First, there are limits on the public's ability to pay for drugs and new drug research. If that was not true, we would instantly increase the NIH budget by large multiples and cease all efforts to reduce drug prices through the use of generics, formularies, or other mechanisms. Attempts to control expenditures on pharmaceuticals are necessary, not because of moral outrage over drug company profits, but because as taxpayers and consumers we have limited resources. While everyone wants to encourage the private sector to participate in new drug R&D, it is important to consider the efficiency of the various financial incentives that reward industry R&D investments.

If a drug company is allowed to earn what amounts to a windfall on a government funded drug invention, it will have profits that may or may not be reinvested in R&D. But the effect of giving this windfall to a drug company is similar to dropping money on the company from an airplane -- it may have some impact on future R&D, but the incentive is highly inefficient.

Most of the companies which now obtain NIH licenses and CRADAs are large and face few liquidity constraints. R&D investments are forward looking. Current R&D spending will be funded if and only if the company expects future returns to be adequate. One might conceivably argue that companies expect to receive these windfalls from government funded drugs as a reward for R&D investments, but the evidence doesn't support even this rationale. The NIH has not linked the windfalls on government funded drug inventions to a company's past or future R&D performance. Bristol-Myers Squibb, for example, is a frequent beneficiary of government funded cancer research, despite the fact that the company has little to show for its own cancer R&D program.(1) Rather than award windfalls to companies who obtain government funded drug technology at bargain basement prices, the government should target its incentives toward those companies who invest and succeed in the R&D process.

2. In a wide range of important cases, changes in drug prices will not delay or discourage development.

When the government's role in funding a new drug invention is extensive and the government controls the intellectual property rights, it can negotiate a lower consumer price without prejudicing the commercialization of the drug. For example, in the cases of ddI and Taxol, the government funded the preclinical research, sponsored the clinical trials, and controlled the intellectual property rights. (2) NIH could have awarded the ddI license or the Taxol CRADA to the firm that offered to charge the lowest consumer price or agreed to a pricing formula that would have benefited consumers, subject to whatever diligence requirements NIH believed were necessary.

We recognize the drug development process is complex, and in some cases it may be appropriate for NIH to waive or modify the fair pricing agreement, particularly when the government's contribution to the drug's development is minor or when NIH does not control the intellectual property rights.(3) However, there are both hard cases and easy cases, and the existence of hard cases should not provide a rationale for eliminating the reasonable pricing clause for both the hard and the easy cases.

3. The government can balance reasonable pricing or cost containment mechanisms with other instruments which increase investments in new drug R&D.

The NIH reasonable pricing clause is only one of several mechanisms that the government can use to control health care costs. Among the range of options are broader review of drug prices patented under the Bayh-Dole Act, loss of exclusive marketing rights under the Orphan Drug Act, deeper Medicaid and Medicare discounts, use of generic drugs and formularies or a general program of compulsory licensing or price controls for pharmaceutical drugs which do not face effective price competition. All of these mechanisms are designed to lower current expenditures on pharmaceutical drugs, and this is expected, in some measure, to reduce incentives for new drug R&D. Of course, if Congress extends insurance coverage for pharmaceutical drugs, this will increase demand and increase R&D incentives. Since the exact terms of any new health care are highly uncertain, it is difficult to predict what new initiatives will be enacted and what the net impact of will be on R&D. However, there are clearly other measures which can more than compensate for any negative impacts. For example. earlier this year several members of the U.S. Senate proposed that one percent of all health care premiums be devoted into a fund for health care R&D, vastly increasing the current level of federal support for health care R&D.

A somewhat different R&D proposal was discussed at a July 27, 1994 hearing of the Senate Committee on Governmental Affairs on the topic of pharmaceutical pricing. Dr. Peter Arno and James Love both separately recommended that the federal government require drug companies to reinvest a minimum percent of their gross sales into R&D projects. TAP recommended a 20 percent minimum R&D reinvestment, although this number could be subject to debate or change. What is important about this proposal, or the Senator's one percent of total premium's proposal, is that the government can guarantee that R&D levels are as high as are socially optimal. Indeed, if every company was required to reinvest 20 percent of revenues from pharmaceutical sales into new R&D projects, every generic drug company would become a source of venture capital for research on new drug therapies. While the government would set a minimum level of reinvestment, the companies would be free to follow market forces in choosing particular investment projects, as they are today.

Similar proposals are being considered elsewhere. A proposal regarding targeted R&D reinvestment was made by the Eastman Commission in Canada in 1985, although it was never implemented. We have urged national R&D royalties or R&D reinvestment requirements in Argentina and Brazil, two countries that are currently considering sweeping changes in laws regarding intellectual property rights for pharmaceutical drugs.(4)

VI. Higher royalties are not a substitute for a reasonable pricing clause.

While there is widespread amazement that NIH royalty income is so low, given the huge amounts of government R&D in pharmaceutical development, there is no support outside of the pharmaceutical industry to replace the reasonable pricing clause with higher royalties. Taxpayers have some interest in higher government royalties, particularly insofar as exports of the technology are concerned, but the overwhelming issue remains the prices the public faces as consumers. Any serious effort to get the government to recoup its investments through royalties will fail on several counts. Among the more important considerations:

• Efficient royalty schemes would be complex, and in many important ways, even more complex to administer than a reasonable pricing clause.

• Truly aggressive royalty schemes would present a conflict between the nation's public health goals and its revenue maximization strategy. Should the government be party to a policy that denies poor segments of society access to a therapy in order to increase government royalties?

• Patients who have already paid for research as taxpayers will object to being asked to pay a second time as consumers.

From the standpoint of economic efficiency, the marginal cost of making a new pharmaceutical technology is often extremely low, and policies which artificially raise prices above marginal costs will reduce social welfare. When the R&D was funded by the taxpayers, the public interest is best served by policies which lead to lower consumer prices, not higher prices.

VII. Reasonable Pricing Methodology.

Over the past several years I have come across several versions of the NIH "model" reasonable pricing clause. The one distributed at the July CRADA forum read as follows:

NIH have a concern that there be a reasonable relationship between the pricing of a licensed product, the public investment in that product, and the health and safety needs of the public. Accordingly, exclusive commercialization licenses granted for NIH intellectual property rights may require that this relationship be supported by reasonable evidence.

This model language is often modified through negotiations. The January 13, 1988 NIH license with Bristol-Myers for the development of ddI read as follows:

LICENSEE acknowledges the concern of the Government that there be a reasonable relationship between licensee's pricing of Licensed Product and the health and safety needs of the public and that this relationship be supported by evidence.

The reasonable pricing clause for the National Cancer Institute's January 1991 (NCI)/Bristol-Myers Squibb Taxol CRADA read:

NCI has a concern that there be a reasonable relationship between the pricing of Taxol, the public investment in Taxol research and development, and the health and safety needs of the public. Bristol-Myers Squibb acknowledges that concern, and agrees that these factors will be taken into account in establishing a fair market price for Taxol.

What happened to the "model" language? In the case of ddI, NIH removed the phrase "the public investment in that product." In the case of Taxol, the government removed the phrase about providing "evidence" to the government to support the reasonableness of the price. Both changes significantly weakened the provision.

In February 24, 1993 hearings before the Senate Committee on the Aging, then NIH Director Dr. Bernadine Healy was stung by criticism of the agency's feeble efforts to obtain lower prices for NIH funded drug inventions. She described the NIH reasonable pricing clause as though it had religious significance.

The difficulty with the reasonable pricing clause is it was a spiritual statement. It was a statement of trust, of understanding that we thought that the companies should recognize the public investment, but in fact, if you look at the contractual agreement, there are no teeth. There is no mechanism at NIH for enforcing it. There is no contractual responsibility on the part of any of the partners to divulge information that would lead to a mechanism to achieve a price. There is not articulation of what pricing strategy might even be. . . .

In response, Senator Cohen and Dr. Bernadine had the following exchange:

Senator Cohen: When you say it is a spiritual thing, or a spiritual provision, it is really a meaningless provision, is it not?

Dr. Healy: I think spiritual things are very meaningful, but they aren't necessarily things you can put your arms around and act on and implement. I think that we believe at NIH that the statement that the public should have a return on its investment is an important thing to articulate in those relationships, even if we don't have the ability to function as a regulatory agency and even if we don't have the ability to put together the teams of economists and lawyers to figure out a price.

Senator Cohen: Let me not engage in any kind of teleological argument with you about the value of spirit in our lives. Let me suggest to you that when the Government undertakes to put provisions in a contract which give the appearance that we are concerned and that we are going to insist upon "reasonable prices," when in fact we have no expertise, no basis, no ability to determine what a reasonable price is. We have no way to monitor what a reasonable price is and no mechanism to enforce it. We are doing a greater disservice than by not having a clause in any event, because we are giving the appearance that we are doing something in fact, when we are doing nothing.

The problems in the present NIH fair pricing clause were well documented in the February 24, 1993 Senate hearing as well as in several hearings held by Representative Ron Wyden's House Subcommittee on Regulation and Technology. Rather than repeat criticisms that we have provided elsewhere, I will focus on the particular factors which are important for rehabilitating the usefulness of the reasonable pricing clause.

From the point of view of the contract language, it is fair to say that the model language is quite vague with respect to pricing methodology. Of course, NIH did itself no favors by weakening the clause in the ddI and Taxol contracts, particularly since the government was in a very strong bargaining position in both cases. Indeed, even with the modified contract terms that were used for ddI and Taxol, NIH still retained a good deal of power to insist on a much lower price. The evidence, however, suggests that NIH's principle problem was not the contract clauses, but the agency's lack of resolve in getting a better price for consumers. It is fair to say that many NIH officials are so hostile to the reasonable pricing clause that we expect them to actively sabotage the provision. One wonders how much matters would change if even a small fraction of the money to pay for the NIH developed therapies was paid for from the salaries of the NIH officials who are responsible for the reasonable pricing clause. We have concluded that many of the high paid NIH officials, all of whom enjoy excellent health care benefits, have little appreciation for the burdens faced by citizens who earn lower salaries and pay for medications out of pocket. The Secretary of Health and Human Services should consider a reorganization which places the responsibility for the reasonable pricing negotiations in the hands of an agency outside of NIH that has a clearer mandate to protect consumer interests.

The industry has rightly pointed out that the extremely vague language in the present model reasonable pricing clause presents uncertainty. Of course, the industry is unlikely to welcome reductions in that uncertainty, if a new more detailed methodology results in lower drug prices. Nevertheless, it is important to move beyond the "spiritual" statements of the present clause, to a more concrete methodology.

In order to move forward, beyond this increasingly tiresome debate over whether or not to control prices, it is a good idea to establish some basic concepts.

1. Information is important.

The government cannot do a good job of evaluating the reasonableness of a drug price without better data. One type of very useful data is the cost of R&D, disaggregated by key benchmarks, such as Phase I, II or III clinical trials or pre- clinical investments. The federal government has historically funded one fourth to one fifth of all clinical trials. These data alone would make a very useful database, but it would be even more useful if the government had the power to compel reporting by the private sector as well. The government needs to collect and evaluate data on the probability of moving from one stage of R&D to another. There is also a great need for data on prices and sales revenues and production costs. Of course, NIH can obtain information of this type through contractual provisions, but the broader reporting under a statutory authority to compel disclosures would be preferred. Of course, it should be added that the price and sales revenue data are already available to the industry from private vendors such as Dun and Bradstreet's IMS service, and the industry already discloses detailed R&D data to its own trade associations and academic consultants, so the government would hardly be breaking new ground by compelling disclosure to the government.

2. Think globally.

The relevant market for pharmaceutical drugs is international. The relevant drug revenues are from international sales, not domestic sales. The government should routinely collect and study drug prices from other countries, including countries that use compulsory licensing to lower drug prices. The U.S. government should work with other countries to coordinate its data collections, and to set goals for sharing the burdens of R&D.

3. Reward companies for value added contributions to research.

In Taxol and ddI the government made a fundamental error. It evaluated prices based upon the costs of other drugs, rather than the value added contributions of the license holder or CRADA partner. It makes little sense to allow a firm that contributes one percent of the expected R&D costs to charge the same price as a firm that contributes 80 percent of the expected R&D costs.

4. Reward risk taking.

Investments in the riskier stages of development are more valuable than investments in more mature development stages. Out of pocket investments should be adjusted for risk. These rules apply to both the government and company investments. To appreciate these risks, the government needs to collect and analyze data on the R&D process, disaggreated by key R&D benchmarks, and to consider expectations rather than ex post results.

5. Don't underestimate the value of the government's research.

Industry consultants make generous adjustments to out of pocket investments, to reflect risks and the time value of money. For example, when the industry invests $1 in Phase I trials, the investment is counted as $11, to reflect inflation, risks and lost profits. Government officials report taxpayer investments in nominal terms, without any adjustments at all. This gives a distorted view of the relative contributions by the government and the industry. The largest area of undervaluing concerns pre- clinical research. The industry estimates that more than two thirds of the cost of a new drug is due to the cost of pre- clinical research, once the investments are adjusted for risk and the time value of money.

6. When possible, rely upon market forces.

In a number of cases, NIH should be able to rely upon market forces to determine reasonable prices. If NIH can articulate a sound pricing rule or method, it should be possible to allow firms to competitively bid to obtain a CRADA or license agreement, on the basis of a bid variable that is related to the eventual consumer price. That bid variable could be the price itself, or a related item such as the gross or net revenue from sales, or even the years of marketing exclusivity.

7. Don't waive the reasonable pricing clause without a public interest finding and public comment.

NIH should retain the flexibility that it already has to waive or modify the reasonable pricing clause, but it should do so only after a finding that the wavier or modification was in the public interest, and after public comment.

8. Take the job seriously.

This is important stuff, and it deserves more than the symbolic attention that it has received in the past. Give more than the "appearance" that something is being done. The government has the opportunity to save taxpayers and consumers billions of dollars, and the industry stands to lose billions of dollars in windfalls on government funded research. Put together a team that is equal to the task.

1. While Bristol-Myers Squibb is the world's largest vendor of cancer drugs, and by far the largest vendor of cancer drugs developed by government funded research, it has yet to discover a cancer drug on its own.

2. These included a patent for ddI and exclusive rights to patient records for Taxol.

3. Of course, NIH already has the authority to do this, and has often modified the model reasonable pricing agreement, even when there was no apparent rationale for the changes.

4. Argentina and Brazil do not currently recognize patents on pharmaceutical drugs. Both countries are facing pressure from the United States to enact new patent laws. The United States negotiators are asking both countries to adopt provisions which are more strict than are required by the new GATT, and in respects, more strict than now exist for members of the European common market or in the United States. Brazil, which has a minimum wage of $65 per month, expects to face significant increases in the prices of medicines, as a result of the changes in the patent laws. My comments about the Argentina situation were made to a meeting of the Argentine Congress on May 10, 1994, and in May 12, 1994 comments delivered at the International forum on "Health Care Reform in the United States and the Situation in Latin America," held in San Carlos de Bariloche, Argentina, sponsored by the Centro Industrial de Laboratories Farmac‚uticos Argentinos (CILFA), and the Association Latinoamericana de Industrias Farmac‚uticas (ALIFAR). The written statement from the May 12, 1994 meeting is available upon request.