An example of American innovation: a transcatheter heart valve
Tim Rue/Bloomberg/Getty ImagesAn example of American innovation: a transcatheter heart valve

The United States has long led the world in medical innovation, and its skill at developing lifesaving drugs and devices produces enormous economic value. In a 2011 report prepared for the Pharmaceutical Research and Manufacturers of America, Batelle Technology, a research organization, estimates that the biopharmaceutical sector pumps more than $917 billion into the American economy annually and employs more than 674,000 workers, whose average annual wages exceed $118,000, more than double the U.S. private-sector average. Those salaries generate billions in state and federal tax revenues. Further, biopharmaceuticals are second only to aerospace products as the nation’s leading export, reaping billions of dollars in sales every year. And let’s not forget that new therapies for everything from cancer to depression enable Americans (and people all over the world) to live longer, healthier, and more productive lives.

America’s leadership in these fields can be attributed to a few key components. They include a strong patent system; a relatively free market for innovation (unlike most developed countries, the U.S. doesn’t impose price controls on new medical products); extremely competitive research universities; generous federal and even state tax credits for research and development; and vibrant capital markets for funding start-ups. Another highly important component is the National Institutes of Health, which devotes over $30 billion annually to academic research on the biological mechanisms of diseases like cancer and Alzheimer’s; no comparable institution exists anywhere else in the world. Finally, the Bayh-Dole Act of 1980 allows American universities that develop new technologies with federal funding to retain sole control of the intellectual-property rights and royalties. Bayh-Dole gives universities an incentive to license promising technologies to private companies, which can then use them to develop drugs and medical devices; it also ensures that those technologies don’t sit on the shelf in university labs because companies can’t be sure who owns them.

Unfortunately, future American leadership in drugs and medical devices is far from guaranteed. In addition to new, nimble competitors springing up in China, India, and Singapore, the United States faces obstacles of its own making, including an overly risk-averse Food and Drug Administration (FDA); counterproductive tax, tort, and education policies; and, above all, the Obama administration’s efforts to centralize control of American health care in Washington. What has taken decades to build can be lost in short order unless we adopt bold policy solutions.

The problems begin with the FDA. The trials for new medicines that the agency requires—larger, longer, and more complicated than ever before—pose a serious threat to future innovation. In 1985, trials averaged about 1,700 patients; by 2005, that number had risen to 4,200. The average drug’s clinical trials lasted just two and a half years in the 1960s, compared with nearly seven and a half years now. It can sometimes take even longer—ten or even 15 years—to bring a new drug to market today, and it can cost $1.3 billion.

The path to market for medical devices doesn’t appear to be much better. In July, an FDA advisory committee voted nearly unanimously to approve an innovative heart valve for severe aortic stenosis, a condition that reduces blood flow from the heart. This valve, an important advance for patients too sick to endure open-heart surgery, can be implanted through a catheter in the thigh. Seventy percent of patients with severe stenosis who received the valve survived, a major improvement over the 50 percent who survived after undergoing other therapies. Great news—but the valve has been available to European patients since 2007. A recent survey of more than 200 device companies found that the FDA’s premarket clearance process for even low-risk medical devices takes ten months, on average, a good deal longer than Europe’s seven months. Tired of the cost and expense associated with FDA approval, frustrated firms are frequently pursuing other markets first, delaying Americans’ access to devices. On average, American patients wait two years longer for access to innovative medical technologies than patients in Europe do.

What effect do longer, more expensive trials and approvals have on medical innovation? Ask Bayer Healthcare Pharmaceuticals’ Jessica Federer, who said at a recent panel at the Council on Foreign Relations that the rising costs of clinical trials reduced the incentive for pharma companies to invest in studies of diseases that can take years to develop, like Alzheimer’s. Even large pharmaceutical firms are killing entire therapeutic areas rather than launch the massive trials that the FDA requires for some chronic diseases.

There are exceptions to the rule of slow FDA approval. Some diseases, such as cancer, are so severe that the FDA worries less about drugs’ side effects and accelerates the approval process for them, which can get them to market more quickly. That’s good news for cancer patients, of course. But it’s also an incentive for pharmaceutical companies to focus on developing cancer drugs, rather than treatments for such conditions as heart disease, diabetes, and obesity, for which the FDA continues to require huge, expensive trials. Several companies, in fact, have deep-sixed their diabetes-research programs, a troubling development when you consider that diabetes is the nation’s seventh-leading cause of death and that the cost of diabetes nearly rivals that of cancer.

The FDA itself isn’t entirely to blame for requiring enormous, lengthy trials. One reason that it’s such a risk-averse organization is that Congress routinely treats it as a scapegoat when a drug or device causes unforeseen side effects. For example, the FDA faced withering criticism from members of Congress after the discovery in 2004 of rare but serious side effects from the painkiller Vioxx. Also in 2004, charges that antidepressants provoked adolescent suicides similarly led congressmen to blame the FDA, even though the charges were never verified; in fact, teenage suicide rates actually declined as the prevalence of antidepressants expanded during the 1990s.

Another barrier to American drug and medical-device innovation is the country’s corporate tax rate, which is among the world’s highest. The United States is unique among developed countries, moreover, in taxing the worldwide earnings of its global firms; other countries tax only the earnings that occur within their borders. The tax on foreign earnings is deferred until the money is repatriated, but that gives firms a perverse incentive to keep their profits offshore, since they’ll take a huge tax hit if they translate foreign earnings into new U.S.-based investments. As Shawn Tully writes in Fortune, this means that low-tax nations will keep getting the “factories, call centers, and labs,” even if it’s “just as profitable before taxes to build the plants in the U.S.”

Medical firms also must grapple with the U.S. tort system, which exposes them to multibillion-dollar class-action lawsuits when someone discovers, years after the FDA has approved a drug or a device for sale, that it can produce rare side effects. This system punishes manufacturers for side effects that they can neither predict nor prevent. Not only does it shift companies’ funding from research and development into defending dubious lawsuits; it discourages them from developing new products that seem likely to generate litigation down the road, such as drugs or vaccines for pregnant women.

Adding to these woes are America’s schools, which underperform dismally in preparing students for jobs in engineering and the life sciences (see “The Excellence Gap”). Until recently, firms compensated by recruiting foreign-born graduates of American universities’ M.A. and Ph.D. programs. The difficulty of obtaining a green card, however, means that it’s becoming harder to attract those students—who are simultaneously being lured home by the increasingly sophisticated life-science sectors in India and China.

But the greatest threat to medical innovation is the Patient Protection and Affordable Care Act of 2010, often called Obamacare. Companies can adapt to fickle regulators, high tax rates, greedy trial lawyers, and a small pool of potential employees, provided that they know, at the end of the day, that their products will reach the market and be paid for at fair prices. But Obamacare’s newly created Independent Payment Advisory Board (IPAB) threatens the market incentives on which innovation relies.

Starting in 2015, if Medicare spending rises above a set threshold, IPAB, a 15-member panel of unelected experts, is supposed to get it under control. But the Obamacare law exempts politically powerful hospitals, nursing homes, and hospices—one-third to one-half of all Medicare spending—from cuts until 2020. So IPAB will be forced to find the savings elsewhere. That means slashing reimbursements for physicians, medical-device manufacturers, and pharmaceutical companies.

The advisory panel is likely to focus on cutting reimbursements for expensive new medicines and medical devices. That’s because these things frequently reduce costs only in the long run. A pricey new severe-arthritis drug that kept patients active and mobile, for instance, might delay their entry into a nursing home by a few years, saving far more money than the drug itself costs. But IPAB must make its cuts annually, meaning that it can’t take into account savings that take years to materialize. Innovative treatments for cancer and other tough-to-treat diseases will be the first to feel the price-control pinch. IPAB could be the coup de grâce for small and medium-size firms already struggling to bring new products to market through the FDA.

Spurring a new wave of medical innovation should start with FDA reform. For starters, Congress should convert the FDA from an agency within the Department of Health and Human Services to an independent agency. Congress should also recommend that the president make FDA commissioner a cabinet-level position. These changes would enhance the FDA’s prestige, raise its public profile, and underscore the importance of its role in medical innovation. Further, Congress should require the FDA to appoint a “chief innovation officer” charged with reducing the cost and time required to bring new products to market. And this officer should report to Congress on his or her progress annually—not every five years, which is typically how often Congress reviews FDA procedures.

One of the FDA’s first priorities should be to create an expedited approval process for drugs aimed at patients with certain “biomarkers”—biological indications of various conditions—since these drugs, by targeting specific subpopulations’ biochemistry, are much likelier to be effective than other medications. In such an accelerated process, a company could sell its drug after early-stage safety testing, but it would have to continue testing, as the drug began to be widely used, to confirm its effectiveness and safety. To give firms an added incentive to develop these drugs, Congress could also offer longer patent protections for products and diagnostics that target subpopulations.

Since innovation doesn’t start at the FDA, Congress should also fund increased collaboration among industry, regulators, and the National Institutes of Health. In Europe, the Innovative Medicines Initiative, funded by $2 billion in E.U. and industry money, brings regulators and companies together to streamline regulations for drug safety and efficacy. Activities like this do occur in America; for example, at the Critical Path Institute in Arizona, drug firms and researchers shared data and discovered biomarkers for kidney toxicity. Knowing about these indicators can speed drug development by weeding out harmful drugs sooner or enabling doctors more effectively to track how patients respond to powerful medications. But the 2011 FDA budget included a mere $25 million for advancing regulatory-science initiatives, including sponsoring collaborative research projects like those at the Critical Path Institute.

Lowering the U.S. corporate tax rate to a competitive level—that is, the OECD average or lower—and eliminating taxes on profits earned abroad and reinvested at home would make building domestic research and manufacturing facilities much more attractive for American firms. Tort reform remains a long-overdue national priority (and not just in health care). Meantime, Congress should create a drug compensation fund similar to the vaccine-injury compensation fund that has helped save that industry from crippling junk-science lawsuits. In such a system, people harmed by side effects disclosed on a drug’s label wouldn’t be able to sue drug companies; instead, they would receive a predetermined level of compensation from the fund for unforeseen but scientifically validated injuries, which would be paid for by a small excise tax on medicines.

A partial solution to the shortage of high-skilled workers would be the adoption of skills-based immigration reforms (see “Capital Gains”). We could, for instance, give automatic green cards to foreign students who obtained degrees in American engineering and life-science programs.

Above all, lawmakers should abolish IPAB. A far better way to reduce Medicare spending would be to cap it, encourage smarter use of that spending by raising participants’ out-of-pocket expenses, and offer seniors the alternative of receiving a voucher to buy a private insurance plan. By allowing seniors to choose among traditional Medicare and private plans, this system would introduce competition based purely on quality and services, both encouraging seniors to seek good insurance and keeping costs down.

These reforms would work wonders in the drug and medical-device industry. The innovation that they unleashed would also perform another immensely valuable service: stemming the rise of health-care costs. Frank Lichtenberg, a health economist at Columbia University, has estimated that for every dollar that Medicare spends on new medicines, it saves $6 in other health-care costs, primarily by reducing the use of physicians’ services and hospitalizations.

In the future, new sciences like genomics will produce drugs and devices that cut costs even further. An example of the promise of genomics that’s already in the marketplace is a $450 test that could, researchers say, save the health-care system over $600 million annually by identifying colon-cancer patients whose tumors have a mutation in a specific gene that makes them unlikely to respond to expensive drugs like Erbitux. Lowering health-care costs will, of course, contribute hugely to American prosperity. It will also let policymakers invest the savings in (among other things) additional basic-science research.

So by streamlining the path to market for new medical devices and drugs, America can maintain its leadership in the field, help control health-care spending, and create thousands of high-paying, high-skilled jobs. Alternatively, we can continue on our current path, overregulating and overtaxing this vital industry—until it finds a home elsewhere.


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