Did Medicare Induce Pharmaceutical Innovation?

The introduction of Medicare in 1965 was the single largest change in health insurance coverage in U.S. history. Providing nearly universal public health insurance coverage for the elderly, it is currently one of the largest health insurance programs in the world. Its introduction had dramatic effects on health insurance coverage and health care utilization for the elderly (Benjamin Cook et al., 2005; Finkelstein, 2005). Since the introduction of Medicare, there has also been dramatic progress in the development of new pharmaceuticals. For example, Cutler and Srikanth Kadiyala (2003) estimate that the development of new pharmaceuticals was responsible for about one-third of the pronounced decline in cardiovascular disease mortality over the last half-century. Many economists have conjectured that Medicare provided part of the impetus for the development of new drugs, especially those most commonly used by the elderly (e.g., Cutler, 2004 and Frank Lichtenberg, 2004). There has been little systematic analysis of this hypothesis, however. An impact of Medicare on pharmaceutical innovation would be consistent with recent empirical evidence of induced innovation in pharmaceuticals more generally. Acemoglu and Linn (2004) and Finkelstein (2004), for example, find that increases in expected demand for certain types of pharmaceuticals are associated with increases in clinical trials and Food and Drug Administration (FDA) approvals for these products. For Medicare to induce innovation in new pharmaceuticals, a necessary (but not sufficient) condition is for it to have increased the demand for prescription drugs among the elderly. Although prior to 2006 Medicare did not cover prescription drugs, it may have indirectly increased demand for prescription drugs since it covered physician care, which may be highly complementary with prescription drug use. In addition, any increase in pharmaceutical demand among the elderly caused by Medicare would have to be large enough to induce technological change in this sector. In this paper, we investigate the effect of Medicare on the development of new pharmaceuticals for the elderly. Our strategy follows the logical steps laid out in the previous paragraph. Our reading of the evidence is that there is no compelling case that Medicare induced significant pharmaceutical innovation. We find no evidence that the introduction of Medicare is associated with an increase in drug consumption among the elderly. Consistent with this, we also find no evidence of an increase in the approval of new drugs more likely to treat diseases that affect the elderly, after Medicare’s introduction.