Innovation and sales may therefore move together for two distinct reasons: first, innovation creates sales of new products and affects the revenues on existing products, and second, sales stimulate innovation. Innovation may also intensify competition between products and therefore reduces prices and margins.
Although a large expected market size may stimulate new pharmaceutical innovation, it may also be the case that new pharmaceutical innovation creates sales and therefore market size. Second, we employ instrumental variables to identify the relationship between innovation and market size. Global revenue data have never, to our knowledge, been used in the literature to measure the response of innovation to market size yet are likely to be an important part of the incentive for firms. Although the United States is the largest and most important national market for pharmaceutical products (with approximately 40% of demand), revenue in other nations is large and growing and serves as an important stimulus to innovation. Other literature focuses only on data from the United States. Much of the existing literature measures intermediate outcomes in the innovation process, such as the number of new clinical trials or available regimens.
These detailed data allow us to calculate an excellent measure of innovation, namely, the number of new molecular entities released on the global market during our time period. First, we have data on the global revenues of all pharmaceutical products over an 11-year period, as collected by pharmaceutical data provider, IMS. In this article, we contribute what we believe to be a valuable new estimate using several improvements to existing methods. This question has no definitive answer in the literature, due to a number of estimation difficulties that we discuss below. The elasticity of innovation is therefore a critical parameter to measure to evaluate the cost to society of price regulation. However, such regulations will affect firms' incentives to invest in discovering new treatments. When governments engage in price regulation and reduce prices for pharmaceutical treatments, the short-run effect may be small because the innovation expenditure is already sunk. More precisely, we estimate the elasticity of innovation (as measured by the number of new chemical entities appearing on the market for a given disease class) to the expected market size as measured by the spending on treatment by sufferers of diseases in that class (and others acting on their behalf, such as insurers and governments). This article quantifies the relationship between financial returns and innovation in the pharmaceutical industry.