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health care reform and technological change

Megan McArdle has an interesting post detailing her reasons to oppose the Obama Administration’s plans to reform the health care system. She makes the reasonable point that the rest of the world free-rides on the US health care system, in the sense that it is the rents earned by pharmaceutical firms/device makers/medical professionals in America that provide incentives for R&D investment. Because I think there is more than a grain of truth to the general thrust of our argument, I’d like to make three counterpoints.

First, there is a particular direction to the technological change that is induced by the waste in our health care system; for example, there is just not a lot of incentive to develop cost-reducing technologies. This point was made a long time ago by Burton Weisbrod, but it bears repeating.

Second, Megan seems to assume that expected profit opportunities are solely determined by future prices. In fact, expected health care expenditures is what should enter the entrepreneurial calculus. Any reform that significantly broadens access to health care could have a positive impact on pharmaceutical profits, even if pressures are brought to bear on the level of pharmaceutical prices. Two papers in the literature suggest that “quantity shocks” can spur pharmaceutical innovation: Amy Finkelstein studies the impact of reimbursement mandates for certain types of vaccines; Acemoglu and Lin look at the impact of population aging on the type of pharmaceutical products being developed.

Finally, while I have no doubt that price controls, holding expenditures constant, would have a negative effect on innovation incentives, we should wrangle with the magnitude. In Megan’s welfare calculus, only the suffering of tomorrow’s patients appear to receive a positive weight. Whether that’s correct depends on the discount rate (one could argue it should be zero), as well as on the elasticity of R&D investment to expected prices. Nailing down that parameter would seem to be rather important before making grand claims regarding the optimality of reform.

Written by Pierre

August 14, 2009 at 9:55 pm

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  1. Pursuing medical innovation on the back of high prices on healthcare (pushing people to be uninsured) seems like a bad way to go. Surely it would be better to offer prizes for drugs, publically funding their discovery, or buying drugs on patent and giving them to all for free.

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    Thorfinn

    August 14, 2009 at 10:59 pm


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