Killing the Golden Goose or Just Chasing it Around the Farmyard?: Generic Entry and the Incentives for Early-Stage Pharmaceutical Innovation

Over the last decade, generic penetration in the U.S. pharmaceutical market has increased substantially, providing significant consumer surplus gains. 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 overall aggregative level of drug development activity has remained fairly stable, 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 decreases early-stage innovations in the same market by 7.9%. This effect is weaker, but still economically and statistically significant in top therapeutic markets where an increase in generic penetration by 10% decreases the flow of early-stage innovations by 2.1%. 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 biologicsbased (large-molecule) products rather than chemicals-based (small-molecule) products as evidenced in their early-stage pipelines. We conclude by discussing the potential implications of our results for longrun consumer welfare, policy, and innovation.