Drug pricing reform has moved to the centre of political debate. In the US, Medicare is beginning to negotiate prices under the Inflation Reduction Act, while the EU is pursuing sweeping changes to exclusivity periods, antibiotic incentives, and shortage management rules. Voters want medicines to be more affordable. But behind this push lies a complex economic challenge: lower prices today may affect the new treatments available tomorrow (Acemoglu and Linn 2004, Kyle and McGahan 2012, Dubois et al. 2015, Cockburn et al. 2016).
Pharmaceutical innovation behaves like a global public good. Once knowledge is created, its benefits spread well beyond borders. Yet the financing of this knowledge remains national, shaped by each country’s reimbursement, pricing, and regulatory system. Research, including Egan and Philipson (2013) and Frech et al. (2023), shows that this disconnect generates powerful international spillovers. A price cut in one major market alters global expected profits and thus global incentives to innovate. Understanding these spillovers is crucial for designing sustainable policy, especially at a moment when countries are rewriting the rules.
Innovation diffuses beyond its invention location
Pharmaceutical innovation has driven large health gains worldwide. In the US, new medicines accounted for 35% of the 3.3 years of life-expectancy gains from 1990 to 2015 (Buxbaum et al. 2020). In Spain, they explained 96% of the rise in age at cancer death between 1999 and 2016 (Lichtenberg 2023). Across more than 50 countries, the health improvements generated by new drug launches far exceeded their costs (Lichtenberg 2005).
Yet diffusion is uneven. High-income countries get earlier access to new medicines, while unsurprisingly, lower-income countries free-ride on innovation financed elsewhere. Even amongst wealthy countries, variation in pricing rules leads to different speeds of access and differing contributions to global R&D.
Innovation is growing but depends on incentives
New drug approvals have risen consistently over the last fifteen years (Figure 1), but sustaining this trajectory requires substantial investment in innovation.
Figure 1 Global trend in new drug approvals
Notes: The solid line represents the total number of newly approved drugs worldwide, and the dotted line represents the number of newly approved drugs per year in the US.
Source: Author’s calculation using Citeline Pharmaprojects data.
Figure 2 shows that R&D investment is still growing. The geography of these R&D investments shows a growing importance of Asia and a lowering of the concentration of clinical trials in the US, except for Phase II.
Figure 2 Active clinical trials per phase per year
Figure 3 Share of US clinical trials per phase per year
R&D for new medicines is extraordinarily risky. Only 8.6% of drugs entering Phase I ultimately reach approval (Dubois 2025). The average R&D cost now exceeds $2 billion per approved drug (DiMasi et al. 2016). Incentives therefore matter greatly.
Push incentives include research grants, National Institutes of Health (NIH) funding, and tax credits. These early-stage inputs have high social returns; for example, a $10 million increase in NIH funding generates 2.3 additional private patents (Azoulay et al. 2019).
Pull incentives (patents, market exclusivity, advanced market commitments, priority review vouchers) reward successful development. Their effectiveness depends heavily on expected revenues, which are directly shaped by national pricing and reimbursement systems. That is why unilateral pricing reforms in one country influence innovation incentives everywhere.
International spillovers
Recent work identifies several pathways through which national policies spill over internationally.
Free-riding and strategic substitution occur when one country raises prices and others feel less compelled to do so. Egan and Philipson (2013) describe pricing as strategic substitutes: if one country pays more, another can pay less without reducing global innovation.
Spillovers across countries also come from regulations like international reference pricing linking domestic prices to foreign ones. These policies compress price differences but distort launch strategies. Firms delay entry into lower-price countries to avoid pulling down prices in high-price markets. Evidence shows delays of up to one year in parts of the EU (Maini and Pammolli 2023). Moreover, if the US adopted reference pricing, reference countries might have to accept higher prices as firms want to preserve US margins (Dubois et al. 2022).
Parallel trade within the EU allows medicines bought in low-price states to be resold in high-price ones. This reduces price variation but shifts bargaining power toward pharmacy chains and distributors. Dubois and Sæthre (2020) show that parallel trade can cut manufacturers’ profits by up to 50%, and firms sometimes restrict supply to prevent arbitrage – raising prices in source countries.
Drug shortages reveal another dimension of spillovers. According to Dubois et al. (2023), high prices in one large country can pull supply away from others, causing shortages. But higher global prices can also incentivise firms to expand capacity, benefiting everyone. Countries that push prices too low risk inducing supply instability.
Thus, most national reforms reverberate across borders, affecting both present-day access and long-term innovation.
A central parameter in these debates is the elasticity of innovation to market size. Estimates vary widely but consistently show a positive relationship (about 1.0 in Acemoglu and Linn 2004; 2.75 for vaccines in Finkelstein 2004; and 0.23–0.30 globally in Dubois et al. 2015). Even at the lower end of these estimates, significant price cuts in major markets can meaningfully reduce global R&D. This is particularly relevant as Medicare negotiations begin and the EU revises exclusivity rules.
In a new paper (Dubois 2025), I find that pharmaceutical revenues matter for innovation but not identically across regions. Indeed, the US and EU markets have strong positive spillovers across innovations from companies headquartered in each of these regions, while the innovations coming from the rest of the world mostly respond to local expected revenue, reflecting the fact that local positive spillovers create additional incentives to invest when the expected revenue is coming more from the company’s headquarters location.
Surprisingly, the elasticity of innovation from companies headquartered in Europe or the US with respect to the expected revenue in the rest of the world is negative, a possible result of international free-riding, but compensated by the positive elasticity of innovation coming from the rest of the world.
Policy recommendations
Because innovation spillovers are global, policies built on purely national reasoning will underprovide innovation. Several reforms could help. Coordinated value-based pricing would reduce distortionary reference-pricing dynamics and bring faster, more predictable access across countries. Global innovation funds could support areas with low commercial returns, such as antibiotics or rare paediatric diseases. Transferable exclusivity extensions, if tightly designed, can deliver high-priority innovation at lower fiscal cost than cash subsidies (Dubois et al. 2022). Agreements on launch sequencing could reduce strategic delays in low-price markets and provide more stable global incentives.
Innovation is too important and too globally interconnected to rely on fragmented national decisions. A reimbursement reform in Canada, a reference-pricing rule in Italy, or a shift in Medicare policy affects not only local patients but the worldwide development of future therapies. If we want sustained innovation alongside affordable access, drug-pricing policy must integrate global spillovers into its design. Innovation is a global public good. It requires global-minded policy.
References
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Azoulay, P, J S Graff Zivin, D Li, and B N Sampat (2019), “Public R&D investments and private sector patenting: Evidence from NIH funding rules”, The Review of Economic Studies 86(1): 117–52.
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Maini, L, and F Pammolli (2023), “Reference pricing as a deterrent to entry: Evidence from the European pharmaceutical market”, American Economic Journal: Microeconomics 15(2): 345–83.