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Financial Proponents – Innovation. Financial rewards have always been a significant tool for motivation. It is a powerful incentive that has pushed firms to innovation, and as a result, materialized some of the most groundbreaking medicine in history. Innovation is very powerful but often comes at an expensive price. By placing a pricing limit on drugs, a stopper is also placed on the emphasis and application of innovation in the industry. Research and development (R&D) of any drug is a lengthy and costly process ladened with uncertainties. While most costs are carefully calculated, there will always be unforeseen obstacles in the process that require additional spendings to resolve. It is imperative to incur these extra expenses to move forward, but in a price-controlled environment, that would also mean a decrease in profits for the producers.
Generally, the most breakthrough drugs are the ones that require the most investment, but even so, not all heavy investments guarantee successful products and therefore, it will always be a risky gamble. This is difficult for pharma companies as they require a degree of financial freedom to incur costs in order to explore different faucets of medicine and research. To be incentivized to do so, firms need to know that they will be compensated accordingly. An example of this is the continuous R&D efforts for Severe Sepsis. This condition affects 500,000 annually around the world and has a mortality rate of 35 – 50%, yet no promising treatment had been discovered despite decades of research (Calfee 1060). It wasn’t until recent years that a clinical trial showed some progress in a treatment which is significantly lowers mortality rates. Had firms given up, they would not have discovered this cure that is now saving thousands. Even though the R&D for this condition has been challenging, many pharma companies were engaged for decades because they all possessed the “small-probability, high-payoff” mindset (Calfee 1061). Firms pursue R&D for less common yet more challenging medical conditions because if they succeed, they receive the patented right and exclusive ability to price-control their drug. However they also understand that if they fail, they will likely not recover their extensive costs (Calfee 1061). With a price ceiling on drug prices, the incentive to innovate would be stripped away as the risk and rewards do not align. From a business perspective, there is virtually no reason to invest heavily on R&D for a cure that has low risk of success and low returns relative to the investment.
This rationale was proven in a proposed healthcare plan from the Clinton administration in 1993. There was a provision in the plan to implement price ceilings on all breakthrough drugs (Calfee 1063). In the following 2 years, while this idea was being debated, the annual domestic R&D expenditures by Pharma firms already decreased by 7%. (Calfee 1063). Evidently, firms became reluctant to spend as uncertainty of cost-recovery in the future increased. The idea of a price ceiling led to lean accounting and firms’ desire to innovate ultimately decreased. Innovation is the key driver of many medical discoveries and price ceilings will have adverse effects on the progression of this industry.
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