If healthcare in the 20^th century was characterised by the successful eradication and containment of communicable diseases – from TB and smallpox to diphtheria, poliomyelitis and influenza – through better sanitation, mass vaccination programmes and the development of antibiotics, it is likely that progress in the 21^st century will be defined by the fight against non-communicable conditions. These include all forms of cancer and tumours, neurodegenerative diseases like Parkinson’s and Alzheimer’s, as well as autoimmune disorders such as multiple sclerosis and rheumatoid arthritis, and chronic conditions like diabetes and heart disease.

We know relatively little about many of these conditions: the cause of neurodegenerative diseases like Alzheimer’s and dementia is still unknown, although substantial achievements have been made in recent years with the identification of biomarkers, i.e. reliable indicators for early diagnosis. Similarly, induced pluripotent stem cells (iPSCs) hold the promise of regenerating declining tissue in all manner of body organs, thus halting and even reversing the progress of conditions like macular degeneration (eyes) and Parkinson’s (brain). Finally, cancer survival rates have been increasing steadily since the 1960s – with wide variation across types – and a combination of early diagnosis and new drug development will ensure that the trend continues in the future.

So, it is a good time to be alive – particularly when compared to any previous time in world history. But as in any other field of human endeavour, success in healthcare means that we face an ever more complex set of diseases, some of which we were not aware of before, others which we formerly did not live long enough to contract. And a common feature of many NCDs is the very particular way in which they interact with each individual’s immune system and organs. This means that not all medications benefit everyone equally, and that while some drugs offer enormous benefits to a subset of patients, on others they can have no or even a negative impact. In short, much of the challenge for 21^st-century medicine amounts to the development of increasingly personalised treatments.

This is where healthcare meets economics. In particular, what are the economic implications of the changing global disease burden? In itself, the growing need for personalised treatment would seem to present a case for greater private involvement in the financing and provision of health services. In an age of ever more diverse and complex conditions, it is unlikely that the centralised structures of public health systems, devised to treat the problems of the 20^th century and centred on primary (GPs) and acute (hospital) care, are best-suited to cope with chronic long-term conditions whose prevalence and effects vary substantially within and across populations. Instead, the flip side of personalised treatment must be the specialisation best delivered by market mechanisms, which are much more nimble and adept than central planning at reacting to changing needs.

It is an issue of incentives for innovation and healthcare delivery, but it also concerns cost. New drugs, like any innovation, are – and have always been – costly to develop. However, whereas pharmaceutical development in previous decades largely focused on diseases afflicting vast numbers of people, enabling drug manufacturers to spread costs widely, many of the drugs needed today have only a limited number of potential beneficiaries, often smaller than the patient population for a particular condition. In some cases, prevalence is too low to justify the cost of development of a new treatment. The many different ways in which these drugs react to individual immune systems can also make the job of judging their cost-effectiveness more difficult.

Some see the answer to these challenges in expanding government involvement and spending on drug development and financing. Indeed, given increasingly costly cancer drugs and moves by insurers to limit their financial exposure to them via higher co-payments and restrictive terms, interest groups in the United States are calling for the federal government to cap cost-sharing by individuals and mandate equal access to all cancer drugs. Price controls never achieve their desired purpose, as they encourage controlled industries – in this case, health insurers – to account for the related costs in other ways – for instance, by raising premiums or removing coverage of certain conditions altogether. And additional interventions to address these unintended consequences just lead to more unintended consequences, degenerating into a perverse spiral. In particular, co-payment caps and coverage requirements will lead insurers and pharmaceutical companies to favour relatively low-cost, existing treatments over higher-cost, innovative (and potentially welfare-enhancing) ones, given reduced financial incentives to develop the latter. Instead of heavy-handed intervention, allowing for innovation in the interaction between drug manufacturers and insurers in order to better align long-term benefits with short-term costs is likely to be more fruitful.

Furthermore, as with virtually every public policy issue where politicians’ gut reaction is to throw money at the problem, there are less costly and more effective solutions to be found on the supply side. In the case of drug development, it is drug approval processes that are ripe for reform. Drug development costs in the United States – the world leader in pharmaceutical output by a long way – quadrupled between 1987 and 2005, and the cost per drug approved by leading pharma companies has been estimated to be as high as $5.8 billion. And, according to a 2012 Manhattan Institute report, drug approval processes, and requirements related to clinical trials in particular, account for 90 per cent of development costs. The key drivers are onerous requirements for supplemental testing even when a drug has not been shown to pose any health risks, and costly delays caused by often unjustified demands for additional data. These problems are arguably no less severe in the EU, where the Food and Drug Administration’s equivalent, the European Medicines Agency, has previously been found to take even longer to approve new drugs than its U.S. counterpart.

The trouble with drug safety agencies like the FDA and the EMA is the classic conflict between the seen and the unseen that Bastiat identified in the 19^th century and Milton Friedman later refined with particular reference to the pharmaceutical case. Faced with the choice of either approving or rejecting a new drug which might – however improbably – turn out to have unexpected side effects on some patients, the incentive for the government bureaucrats making the decision is to err on the side of caution, i.e. to reject the drug. The slimmest possibility of a drug proving hazardous carries much more weight than the potential benefits to be derived by patients. The seen – a potentially risky new treatment being blocked in the name of public safety – takes precedence over the unseen – a possibly life-changing drug for thousands of people. But these people will never know what they missed.

These perverse incentives were already clearly at play at the time Friedman was writing, in the 1960s and 1970s. But arguably, recent developments in healthcare and the rise of NCDs as outlined above have rendered traditional drug-approval processes even more inadequate. Stringent safety requirements could have been justified when the vast majority of drugs were aimed at large swaths of the population, and thus unanticipated side effects could quickly escalate into major crises (as happened with Thalidomide). However, in today’s context of specialist drugs for patients who have few alternatives at their disposal, the cost of delays as a result of the “better safe than sorry” approach is magnified – and the potential benefits of speedier approval are greater than ever. Pharmaceutical companies are taking advantage of every available opportunity to accelerate development: an increasing number are using expedited pathways – first introduced in the late 1980s, at the height of the HIV epidemic – for drugs aimed at life-threatening conditions and rare diseases. Nevertheless, it is time for regulators to adjust to the new reality and make speedy approval the default pathway.

Thus, while policymakers’ attention is largely devoted to the demand side, it is the supply side that is driving ever-higher drug development costs. Government regulation is the problem, not the solution. This raises a broader question – what factors drive a country’s performance in pharmaceutical development and innovation? Which are the key factors, and are they demand- or supply-side-driven?

The latest study to tackle this question is the Scientific American Worldview Scorecard on biotechnology, which ranks countries on their innovation potential in this field, not exclusively but largely relating to pharmaceuticals. The categories used range from IP protection and capital availability to resource intensity and productivity – measured as the number of public biotech companies and their revenues. The results are as might be expected, with the United States at the top – thanks, in particular, to its leadership in the productivity and IP categories – followed by a mix of Nordic, Anglosphere and European countries, as well as knowledge-intensive economies like Singapore, Hong Kong and Ireland. Conversely, countries lacking biotech investment, adequate patent protection and an educated workforce tend to rank at the bottom.

Arguably, the most salient lesson to be drawn from the scorecard is that the broad categories, which assess a country’s business environment in a very general way (e.g. regulatory quality, rule of law) are the best predictors of a country’s overall ranking. By contrast, categories like government support for R&D are relatively poor predictors. This suggests that there is no need for policymakers to specifically try to promote pharmaceutical innovation. All it takes is a climate which is generally business- and investment-friendly.

The results may seem intuitively plausible, yet they are hardly reflected in public discourse, which often decries private investment in pharmaceutical innovation as greedy and exploitative, while calling for greater government control and taxpayer funding of research. Meanwhile, the detrimental effect of burdensome regulation, bureaucracy and a lack of legal certainty is often overlooked, even though the latter are clear drivers of escalating costs and low performance by countries.

The rise of specialised medicine aimed at tackling non-communicable diseases has the potential to unleash a wave of innovation in healthcare. The development of effective new drugs to treat the specific needs of individual patients will play a large role in it. Governments, particularly in knowledge-intensive economies like the United States and Europe, must confront the need to simplify drug-approval processes to make research into complex age-related and rare conditions financially viable. This will not only lower development costs for existing players in the sector, but it will also attract smaller companies that have long been shut out of the market by the barriers to entry created by regulation. In pharmaceutical innovation as in many other areas of economic life, supply-side reform holds the key.

Diego Zuluaga is the IEA’s International Research Fellow.