R&D incentives and innovation spillovers: evidence from the European orphan drug regulation

This paper, explores the impact of a regional innovation policy for incentivizing drug innovation, on different R&D phases and outcomes, within a global market. According to the OECD(1), 45% of global pharmaceutical sales come from the United States, 30% from Europe, and 9% from Japan while the US retains the highest share of R&D expenditure (58%) compare to EU (28%) as reported by the Association of the British Pharmaceutical Industry (2). In Europe, the UK has the highest share if exchange rate effects are excluded. Specifically, we exploit the European Commission's Orphan Drug (OD) legislation, which was implemented in 2000, two decades after the US Orphan Drug act (1983). Both legislations are enhancing rare diseases innovation through drug regulatory and financial incentives, mainly through a market exclusivity period independent of the patent monopoly. Our aim is to evaluate the impact of the EU legislation and identify potential spillovers in i) different phases of the R&D process, ii) different drug categories, and also to iii) show that a regional regulation, such as the European, has an impact on the global market. To evaluate and estimate the effects of this policy implementation, we employ a difference-in-differences approach, by utilizing data from the Pharmaproject© drug pipeline database, Questel-Orbit© patent intelligence database and the Wharton Research Database (WRDS) business intelligence research platform. Our sample consists of 61 pharmaceutical firms among the top R&D intensive firms for the period between 1997 and 2003 according. The variables explored for each firms are: R&D budget, Sales revenue, number of preclinical R&D projects, number of Phase 1, phase 2, and phase 3 clinical trials, number of registered and launched drugs, number of patent application by priority date or publication date, number of Orphan Drug status, number of Rare Diseases (RD) or cancer therapeutic indications, number of generic drugs, and merger/acquisition experience. Our results show that the OD regulation leads to a marginal increase of the number of Phase I and Phase II clinical trials for the firms' global portfolio of drugs. This increase is at the level of 1.2 clinical trials on average for each firm in each of these phases. On the other hand, the regulation does not affect earlier and later stages of the drug discovery and development process, such as patent activity, preclinical studies and Phase III clinical trials. The control variable of firm's gross sales affect patents and Phase II clinical trials positively, but with low magnitude. In addition, after controlling for generics drugs production, we find a significant positive increase at the preclinical stage and all the clinical trials phases. Moreover, the acquisition experience does not determine innovation at any stage. In addition, we find significant evidence that the orphan drug regulation leads pharmaceutical companies to increase their innovation output on specific drug categories such as drugs for rare diseases and cancer drugs. Particularly, this effect causes an average increase of 2.39 and 4.5 drugs for rare diseases and cancer drugs, respectively. The gross sales control variable and the acquisition experience do not influence cancer and rare disease innovation, while generics drugs production does. Overall, our findings suggest that firms respond positively to the legislation, by shifting their innovation activity towards cancer and rare diseases drugs. At the same time, their total drug portfolio is also positively affected, but marginally and in specific R&D phases, revealing a short-term strategy from their side.