Promoting Innovation in Small Markets: Evidence from the market for rare and intractable diseases

In many medical care markets with limited profit potential, firms often have little incentive to innovate. These include the markets for rare diseases, "neglected" tropical diseases, and personalized medicine. Governments and not-for-profit organizations attempt to promote innovation in such markets, but empirical evidence on the policy effect is limited. We study this issue by analyzing the impact of a demand-side policy in Japan, which reduces the cost sharing of patients with some rare and intractable diseases and attempts to establish and promote the treatment of those diseases. Using clinical trials data taken from public registries, we identify the effect of the policy using a difference-in-difference approach. We exploit the institutional detail that the diseases covered by the policy increased in an arbitrary fashion over time. We find that the demand-side policy increased firms' incentive to innovate: firm-sponsored new clinical trials increased by as much as 181% when covered by the policy. This result indicates that the demand-side policy can be an important part of innovation policies in markets with limited profit potential.