Regulation and Welfare: Evidence from Paragraph IV Generic Entry in the Pharmaceutical Industry

Abstract

With increasing frequency, generic drug manufacturers in the United States are able to challenge the monopoly status of patent-protected drugs even before their patents expire. The legal foundation for these challenges is found in Paragraph IV of the Hatch-Waxman Act. If successful, these Paragraph IV challenges generally lead to large market share losses for incumbents and sharp declines in average market prices. This paper estimates, for the first time, the welfare effects of accelerated generic entry via these challenges. Using aggregate brand level sales data between 1997 and 2008 for hypertension drugs in the U.S. we estimate demand using a nested logit model in order to back out cumulated consumer surplus, which we find to be approximately $270 billion. We then undertake a counterfactual analysis, removing the stream of Paragraph IV facilitated generic products, finding a corresponding cumulated consumer surplus of $177 billion. This implies that gains flowing to consumers as a result of this regulatory mechanism amount to around $92 billion or about $133 per consumer in this market. These gains come at the expense to producers who lose, approximately, $14 billion. This suggests that net short-term social gains stands at around $78 billion. We also demonstrate significant cross-molecular substitution within the market and discuss the possible appropriation of consumer rents by the insurance industry. Policy and innovation implications are also discussed.