Starving (or Fattening) the Golden Goose?: Generic Entry and the Incentives for Early-Stage Pharmaceutical Innovation

Abstract

Over the last decade, generic penetration in the U.S. pharmaceutical market has increased substantially, providing significant gains in consumer surplus. What impact has this rise in generic penetration had on the rate and direction of early stage pharmaceutical innovation? We explore this question using novel data sources and an empirical framework that models the flow of early-stage pharmaceutical innovations as a function of generic penetration, scientific opportunity, firm innovative capability, and additional controls. While the aggregate level of early-stage drug development activity has increased, our estimates suggest a sizable, robust, negative relationship between generic penetration and early-stage pharmaceutical research activity within therapeutic markets. A 10% increase in generic penetration is associated with a 7.9% decline in all early-stage innovations in the same therapeutic market. When we restrict our sample to first-in-class pharmaceutical innovations, we find that a 10% increase in generic penetration is associated with a 4.6% decline in early-stage innovations in the same market. Our estimated effects appear to vary across therapeutic classes in sensible ways, reflecting the differing degrees of substitution between generics and branded drugs in treating different diseases. Finally, we are able to document that with increasing generic penetration, firms in our sample are shifting their R&D activity to more biologic-based (large-molecule) products rather than chemical-based (small-molecule) products. We conclude by discussing the potential implications of our results for long-run welfare, policy, and innovation.