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5 4 ~ o00k Legal.. Backgrounder N H STTO 2009 MASSACHUSETTS AVENUE, NW • WASHINGTON, D.C. 20036 •(202) 588-0302 LnvAL FOUNDATION _ Vol. 9 No. 39 November 14, 1994 FDA PARALYSIS RAISES HEALTH CARE COSTS by Alan M. Slobodin and Roman P. Storzer The United States has traditionally led the world in the medical device and pharmaceutical industries. According to a study by French economist Etienne Barral, 45 percent of all globalized drugs in the last 15 years have been developed by American firms, nearly three times its nearest competitor. T. DUESTERBERG, ET AL., HEALTH CARE REFORM, REGULATION, AND INNOVATION IN THE MEDICAL DEVICE INDUSTRY 2 (Hudson Institute 1994). Sixty-eight percent of all patents granted in the U.S. for medical devices went to Americans (compared to only 52% in all industries combined). Id. Innovation, fostered by successful investment and patent protection, has accounted for the success of this manufacturing sector, which produced a $5 billion trade surplus in 1993 on exports of $15 billion. U.S. Department of Commerce, International Trade Administration, U.S. INDUSTRIAL OUTLOOK 1994. The continued prosperity of this industry, however, is jeopardized by the persistent and overreaching regulation of the Food and Drug Administration (FDA). The high costs of health care in America are in part attributable to the cost of medical device and drug regulation in the diverse forms of iuser fees, lengthy application processes, delays and uncertainty in approvals, and marketing and labeling restrictions. This tax on innovation has driven drug prices higher, diminished new research and development, made investment in biotechnology more expensive, and forced firms to locate manufacturing operations overseas. As Michael Porter and some of his colleagues at the Harvard Business School have noted, encouraging new medical technologies and treatment is a key to controlling costs in health care in the future. M. Porter, et al., Innovation: Medicine's Best Cost Cutter, N.Y. TIIvIEs, Feb. 27, 1994, § 3, at 11. Regulatory Background. The FDA has the most bureaucratic screening process in the world for new drugs and devices. The drug approval process begins with preclinical testing of a compound in a laboratory and on animals to determine whether the compound is biologically active and safe. This process takes an average of three and one-half years. If successful, researchers file an Investigational New Drug application (IDE) with the FDA, pursuant to 21 C.F.R. § 312.21, which requires a three- phase clinical testing procedure on human subjects: Phase I: The compound is tested to Phase II: Effectiveness of the new Phase III: Confirmation of earlier determine safety and dosage, drug is neasured, involving efficacy tests is determined using involving a small number of hundreds of volunteers. thousands of volunteers in treatment volunteers. Approxintate length: 1 Approximate length: 2 years. and control groups. Approximate t~ year. 3 years. Q .~ W Alan M. Slobodin is President 'of the Washington Legal Foundation's Legal Studies Division. ~ ~ Roman P. Storzer is a WLF Fellow. ~ WLF publications are available on the Mead Data Central LEx1s/NF.XXIS® online information service. The Washington Legal Foundation ("WLF") is a 501(C)(3) tax exempt organization and is America's largest pro-free enterprise public interest law & policy center. This Legal Backgrounder is one of a series of original papers written especially for and published hv WI F'~ I Pnal Studies Division.

t J Once these tests are completed (to the FDA's satisfaction - they may find them insufficient and order more) the filing of documentation which t icall a ins amounts to more than 200 000 es be , y g . , yp p , g , 1T. Bunker, A New Prescription for Biotech? FDA Regulation Has Industry Singing The Blues, INVESTOR'S BUSINESS DAILY, Nov. 4, 1994, at Al, A2. This comprehensive application must include all preclinical studies, test results, and manufacturing and labeling details, as well as the scientific rationale behind the drug. 21 C.F.R. § 312.23. The average time required to complete the filing and application process is two and one-half years, increasing the average total time required for a new drug to reach the final approval stage to 12 years. According to the Pharmaceutical Manufacturers Association, only one out of 5000 new drugs completes this entire process successfully. C. Lochhead, Deadly Overcaution; FDA Assailed For Slow Testing Of New Drugs, SAN FRANCISCO CHRONICLE, Oct. 26, 1992, at A l. Medical device application delays have similarly risen: Average 510(k) review times have risen from 98 days in 1990 to 213 days for the first six months of fiscal year 1994; premarket approval (PMA) applications took 840 days in the first six months of fiscal year 1994, twice as long as in 1990. The Medical Device User Fee Act of 1994: Hearings on H.R. 4728 Before the Subcomm. on Health and the Environment of the House Comm. on Energy and Commerce, 103rd Cong., 2d Sess. (1994) (statement of Robert H. O'Holla, Vice President of Regulatory Affairs, Johnson & Johnson). This detailed regulation of clinical testing, which adds enormous costs to new drugs and medical devices, seriously impedes development and innovation. The cost of just one successful drug to complete this process is approximately $231 million, according to a famous Tufts University study.' Some compounds take much longer, as long as eight or nine years, just to pass through final FDA reviews alone. The untold cost in lives wasted by delays in the FDA approval process is multiplied when considering the number of compounds which will never be developed because it is just too expensive to do so. Another hidden cost, but just as relevant, is that of foregone surgery. The $75 and $60 monthly drug treatment for ulcer or cholesterol conditions, respectively, may seem high, but it is in fact a more efficient treatment than painful surgery, which, according to the U.S. Health Care Financing Administration, averages $28,900 for ulcer surgery and $46,000 for a coronary bypass. Consequently, the development of new drugs also alleviates the rising cost of health care. The FDA Adds Unnecessary Risk To Investment. The absolute cost of pharmaceutical development is not the only critical impediment to the pharmaceutical industry. The uncertainty of FDA approval policy is responsible for much of the unnecessary risk attributed to these firms by Wall Street. In a recent poll among medical device manufacturers, 46 % of those questioned believed that the FDA almost never or never provided sufficient guidance about when a 510(k), PMA or IDE application was required; 57 % stated that the FDA applied its guidance instructions retroactively to their submissions. Companies that survive through most of the clinical stages are finding that they have very little money left - and much more difficulty raising capital - during the final stages of testing. The result is neglect of other projects as well as the risk that a high-profile drug will fail testing because of insufficient funds. Many biotechnology companies are therefore downsizing their operations and concentrating on shorter-term products. C. Prince, Downsizing Hits Biotech Industry, BOSTON BUSINESS JoURNAL, Sept. 23, 1994, at 1. Even with these adjustments to the regulatory climate, pharmaceutical stocks are trading at near all-time lows. The cost of entry into this industry has risen by a factor of more than 10 times since the 1960s. The Medical Device User Fee Act of 1994: Hearings on H.R. 4728 Before the Subcomm. on Health and the Environment of the House Comm. on Energy and Commerce, 103rd Cong., 2d Sess. (1994) (statement of William George, President, Medtronic, Inc.) [hereinafter Hearings]. Delays in approval add to the risk of investment, increasing the cost of capital necessary to develop these drugs and put 'Congressional allies of the FDA, in ordering a 1993 study by the Office of Technology Assessment to refute these findings, were surprised to learn that OTA concurred with the findings, setting the "reasonable upper bound" on this cost at •$359 million, up from $54 million in 1976. Report Says Recent Legislation to Cost Industry $14.5 Billion Over Five Years, HEALTH CARE POLICY REP. (BNA) No. 35, at D-39 (Nov. 8, 1993). Copyright 0 1994 Washington Legal Foundation 2 ISSN 1056 3059

y f them through clinical trials.2 In a recent Coopers & Lybrand study, investment prospects infpc the biotechnology industry were unfavorable, with publicly-traded shares falling 29 % in 1992 and 1993, ~ underperforming the S&P 500's 8% increase. Wall Street Remains Cool On Biotech, BIOMEDICAL MARKET NEWSLETTER, Jan. 1994. This depressed market has forced small companies to finance their projects with venture capital, and venture capital, discouraged by FDA policy, is venturing abroad. To further increase the risk faced by investors in pharmaceutical firms, the revitalized agency has greatly increased its enforcement activity, intensifying the costs of non-approval or other administrative or judicial action: ~ ........................ ... :.::: .:: ...: .: .:: ... w:::: nx ~ n:i: ~:C{•:•}'~'• ' :: ........... .......... : . .~ ... . . .... ...~ :..!•.::...:... . .4~a~: Year Recalls Prosecutions Injunctions Reg. Letters 1988 1,526 24 17 450 1989 2,183 16 13 370 1990 2,352 19 9 498 1991 2,858 43 21 832 1992 2,922 52 31 1,564 Source: E. Greenberg, Has the FDA really been revitalized? PACKAGING DIGEST, Jan. 1994, at 20. Research And Development Is Hampered By FDA Regulations. FDA policies have established an environment in which the research and development of truly new products is becoming less and less feasible in the United States. R&D, the measurement of technological intensity in an industry, accounts for 3% of manufacturing companies' sales as a whole. Members of the Pharmaceutical Manufacturers Association spend 16% of their sales on R&D. M. Weidenbaum, ~ Remarks before the Pharmaceutical Manufacturers Association (delivered Apr. 25, 1994; reprinted in 60 VITAL SPEECHES 538 (June 15, 1994)) [hereinafter P.M.A. Remarks]. These expenditures account for 77.5 % of sales for firms with revenues of less than $5 million. Health Care Technology Institute, Variation in Research and Development Spending Within the Medical Technology Industry, INSIGHT, June 1993. Backlogs of approvals, however, limit the industry's ability to advance its new technological developments. In a dismal illustration of this dynamic, the pharmaceutical industry had introduced an average of more than three times as many drugs in the years before the adoption of approval requirements in the 1962 Amendment (54) than after (16), according to Duke University's Henry Grabowski. C. Warden, The Prescription for High Drug Prices; Factors Contributing to Rising Prescription Drug Prices, CONSUMERS' RESEARCH, Dec. 1992, at 10. The effect of FDA policy is further aggravated by clinical studies that require randomized, concurrent controls, where new devices must be tested against controls of FDA-approved devices. However, for many devices (e.g., orthopedic implants), their FDA-approved counterparts are so obsolete that physicians refuse to implant them just to satisfy an FDA-mandated efficacy decision, making control testing impossible. Research and development is therefore thwarted by testing requirements that would compromise medical care and ethics. See D. Miller, How We Are Regulating Ourselves Out of Business, THE HERITAGE LECTURES, No. 482 (DEC. 8, 1993). • zThis is already an extremely high-risk industry; as discussed, supra, practically all new product ideas do not make it to profitable production. Even when they do, the investment takes a very long time to recoup, if at all, in sales of the product. A Duke University study of one hundred marketed drugs found that the investment was not covered by sales revenue in the majority of cases. C. Warden, The Prescription for High Drug Prices; Factors Contributing to Rising Prescription Prices, CoxsUMEits' RESEARCH, Dec. 1992, at 10. This problem is further exacerbated by the fact that patents are granted for only 17 years (after which generic versions can be produced and undercut the initial developer's price) - leaving only an average of five years after development and approval during which drug companies can recover their investment. :~:5•~ Copyright ° 1994 Washington Legal Foundation 3 ISSN 1056 3059

Regulations Forcing the Manufacture and Sale of Medical Products Overseas. FDA's approval delays are the impetus for companies to take their products abroad. Firms in the United States r are downsizing and moving to friendlier regulatory climates such as the United Kingdom, Japan, Germany, Belgium, and the Netherlands. Clearance processes are much easier and quicker and ~narketing restrictions more relaxed. Capital outflow from the domestic medical technology industry has Increased threefold from $321 million to $993 million in this decade alone. W. George, Hearings. In the ten-year period from 1977 to 1987, 114 new drugs were available sooner in the U.K. than in the U.S., compared to 41 being available earlier in the United States. M. Weidenbaum, P.M.A. Remarks. Cardiovascular medicines were, on average, delayed three years longer to be marketed in the United States, respiratory medicines - five years. A Gallup Poll conducted this year examined 58 medical electronics manufacturing firms in the U.S. to determine if the jobs in this industry were moving off-shore. Findings ranged from large majorities stating that they experienced delays by the FDA and had increased administrative costs for device applications to stating that they released more products outside the U.S. than domestically (55%), reduced the number of employees in the U.S. due to FDA delays (40%), increased investment in foreign operations (29 %), and relocated manufacturing operations overseas (17 %). Gallup Poll Says FDA Backlog of Device Reviews Jeopardizes Patients and Jobs, BIOMEDICAL MARKET NEWSLETTER, June 1994. Given that the total U.S. medical device manufacturing industry is worth $40 billion, and a crucial segment of export trade, this is a very alarming trend. To avoid FDA requirements, pharmaceuticals and medical device manufacturers are more frequently moving production to less regulated countries.3 The disturbing result has been that the medical technology industry, having had an average annual increase in job growth between 1988 and 1992 of 3.4 %, decreased to 0.3 % in 1993, and actually declined by 0.7 % in the first quarter of 1994, according to the U.S. Bureau of Labor Statistics. The Medical Device User Fee Act of 1994: Hearings on H.R. 4728 Before the Subcomm. on Health and the Environment of the House Comm. on Energy and Commerce, 103rd Cong., 2nd Sess. (1994) (statement of Alan H. Magazine, President, Health Industry Manufacturers Association). If this trend continues, American medical technology's $4.7 billion trade urplus in 1993 and 90 % share in the domestic health care market are sure to shrink. Id. ; See also S. egan, Med-Tech Counters Trade Deficit, MINNEAPOLIS-ST. PAUL CITYBUSINESS, Sept. 2, 1994, at 16 (interviews with corporate officers from Medtronic Inc., Schneider (USA) Inc., Medical Alley, and LecTec Corp., discussing the shifting of manufacturing operations overseas); R. Pristave, Pre-Market Clearance Under 510(k): Is there A Better Way ?, BIOMEDICAL MARKET NEWSLETTER, Mar. 1994; T. Bunker, A New Prescription for Biotech? FDA Regulation Has Industry Singing the Blues, INVESTOR'S BUSINESS DAILY, Nov. 4, 1994, at Al (quoting Washington lawyer and former FDA general counsel Peter Barton Hutt that he "send[s] at least one company a week abroad"). Conclusion. Current FDA regulatory policy creates enormous risks to firms, shifting domestic labor, capital, and development overseas. As the goals of the FDA remain unresolved, the costs and uncertainties of required clinical testing diminish return on investment in this industry, both in terms of costs of compliance and the decreased revenue caused by the reduction in time to market their products before generic versions of drugs are available. Sensible reforms are necessary to maintain the United States' status as the leader in medical technology and innovation and to reduce health care costs. M 3A 1993 study by the House Energy and Commerce Committee found that at least twenty-six life-sustaining cardiovascular products were not available in the United States that had been approved overseas. SUBCOMMIITTEE ON OVERSIGHT AND INVESTIGATIONS, LESS THAN THE SUM OF ITS PARTS: REFORMS NEEDED IN THE ORGANIZATION, MANAGEMENT, AND RESOURCES OF THE FOOD AND DRUG ADMINISTRATION'S CENTER FOR DEVICFS AND RADIOLOGICAL HEALTH, H.R. REP. No. 103-N, 103d Cong., 1st Sess. 5 (1993). 10CoPYright© 1994 Washington Legal Foundation 4 ISSN 1056 3059 To receive information about previous Washington Legal Foundation publications contact Alan M. Slobodin, President, Legal Studies Division. Material concerning WLF's other legal activities may be obtained by contacting Daniel J. Popeo, Chairman.