The Effect of Reference Pricing on Pharmaceutical Innovation

With roots in post-9/11 legislation, the Pandemic and All-Hazards Preparedness Act (PAHPA) has for nearly two decades been a vital component of U.S. national security as it relates to our public health infrastructure, biosecurity, and emergency response measures. Up for reauthorization this year, the U.S. Senate Committee on Health, Education, Labor, and Pensions (HELP) has released a bipartisan discussion draft on updating the PAHPA. As the first reauthorization following the COVID-19 pandemic, the draft contains important updates relating to emergency readiness and response procedures. 

Outside this bipartisan discussion draft is a proposal to impose “reasonable pricing” requirements in the pharmaceutical industry. This measure would require all drugs, technology, countermeasures, and products developed with support from the CDC or Biomedical Advanced Research and Development Authority (BARDA) to be sold at the lowest price among  G7 nations

Though described by its proponents as an expedient means to lower the cost of pharmaceuticals to American consumers, this reference pricing scheme will cause long-term harm to the nation's innovation system because it will disrupt the circulation between revenue and research and development that underpin collaborations across industry, university, and public and private research organizations. 

Reduction in R&D Spending

In the pharmaceutical innovation ecosystem, revenue, research and development (R&D), and market are fundamentally interconnectedThis means that a decline in revenue will lead to a reduction in research and development of new drugs and treatments.

In 2021 the U.S. pharmaceutical industry invested over 102 billion dollars, or 21.2 percent of total sales, into R&D. On average, it takes at least ten years and 2.17 billion dollars for a new drug to be approved by the FDA. With only 10 percent of new drugs passing clinical trials and achieving approval, revenue losses incurred during drug development must be offset by the revenue brought in by successful pharmaceutical products and technology. These revenue losses will not be recovered if prices of successful drugs are capped.

This loss in revenue will lead to a reduction in research and development activities, curtail innovation, and slow advancements in biotechnology. Recent analyses of the impact of the Inflation Reduction Act (IRA) and its pharmaceutical price setting for Medicare patients demonstrate the potential adverse effects of price controls on pharmaceutical innovation. The National Pharmaceutical Council found that across drug categories, a reduction or even the threat of a reduction of revenue decreased innovative output, resulting in fewer clinical trials and new drug approvals. Research conducted by the Congressional Budget Office found that the IRA's implementation of pharmaceutical price-setting, which mandates a reduction in out-of-pocket costs for seniors, may result in a 10 percent decrease in the number of new drugs entering the market over the next twenty years. A similar study conducted by a research team with the University of Chicago found that price controls could have an even larger effect on pharmaceutical innovation, resulting in R&D efforts being reduced by 12 percent, resulting in 135 fewer drug approvals by 2039. Shortly after implementing the IRA's price controls, pharmaceutical companies began announcing reductions in R&D efforts, with research into rare disorders and cancer treatments suffering the most. 

Ecosystem Impacts

Price caps on pharmaceuticals have negative downstream impacts across the innovation ecosystem. Pharmaceutical companies reacting to price controls may in turn cut back on R&D partnerships with emerging biopharmaceutical companies and universities, limiting their activities in support of applied research, development, scale up and commercialization of new remedies. Particularly vulnerable are emerging biopharmaceutical companies that account for 80 percent of the R&D pipeline. Legislation that leads to a reduction in research and development support could threaten the viability of these smaller biopharmaceutical companies and degrade the innovation system supporting the development of new technologies. 

Corporate R&D funding facilitates invaluable technology partnerships between universities and the private sector and leads to the creation of hundreds of new technological products. Reference pricing threatens to diminish this funding, jeopardizing potentially invaluable biotechnology innovations. With over 300,000 Americans employed in the pharmaceutical and medical manufacturing industry, the downstream and systemic effects of less research and development could have tangible effects on the U.S. economy and pharmaceutical manufacturing ecosystem.

While there is no easy fix for lowering consumer drug prices, reducing costs in other facets of the pharmaceutical distribution process could be a solution. Proposed legislative measures such as addressing prescription price increases due to pharmacy benefit manager practices and expanding health savings account access to Medicare-eligible consumers that could alleviate consumer costs need to be carefully evaluated. Ultimately, policymakers need to look beyond short-term price cuts for consumers and examine how policies can help grow a robust and resilient innovation system that delivers effective, affordable, and accessible drugs and treatments.

Bailey Crane is a research intern with the Renewing American Innovation (RAI) project at the Center for Strategic and International Studies (CSIS) in Washington, DC.

Bailey Crane

Research Intern, Renewing American Innovation Project