Green Gas Emissions, Risks and Uncertainty: When Kenneth Arrow Speaks – Just Listen

Kenneth Arrow explains the general issue thusly:

Two factors differentiate global climate change from other environmental problems. First, whereas most environmental insults – for example, water pollution, acid rain, or sulfur dioxide emissions – are mitigated promptly or in fairly short order when the source is cleaned up, emissions of CO2 and other trace gases remain in the atmosphere for centuries. So reducing emissions today is very valuable to humanity in the distant future. Second, the externality is truly global in scale, because greenhouse gases travel around the world in a few days. As a result, the nation-state and its subsidiaries, the typical loci for internalizing externalities, are limited in their remedial capacity. (However, since the United States contributes about 25% of the world’s CO2 emissions, its own policy could make a large difference.)

While Arrow notes that the critics of the Stern Report cite the role of uncertainty as their rational for taking no action, he fires back with his own analysis of the roles of uncertainty and risk.

There is greater disagreement about how much to discount the future simply because it is the future, even if future generations are no better off than us. Whereas the Stern Review follows a tradition among British economists and many philosophers against discounting for pure futurity, most economists take pure time preference as obvious. However, the case for intervention to keep CO2 levels within bounds (say, aiming to stabilize them at about 550 ppm) is sufficiently strong to be insensitive to this dispute. Consider some numbers from the Stern Review concerning the future benefits of preventing greenhouse gas concentrations from exceeding 550 ppm, as well as the costs of accomplishing this. The benefits are the avoided damages, including both market damages and non-market damages that account for health and ecological impacts. Following a “business as usual” policy, by 2200, the losses in GNP have an expected value of 13.8%, but with a degree of uncertainty that makes the expected loss equivalent to a certain loss of about 20%. Since the base rate of economic growth (before calculating the climate change effect) was taken to be 1.3% per year, a loss of 20% in the year 2200 amounts to reducing the annual growth rate to 1.2%. In other words, the benefit of mitigating greenhouse gas emissions can be represented as the increase in the annual growth rate from today to 2200 from 1.2% to 1.3%. As for the cost of stabilization, estimates in the Stern Review range from 3.4% of GNP to -3.9% (since saving energy reduces energy costs, the latter estimate is not as startling as it appears). Let’s assume that costs to prevent additional accumulation of CO2 (and equivalents) come to 1% of GNP every year forever, and, in accordance with a fair amount of empirical evidence, that the component of the discount rate attributable to the declining marginal utility of consumption is equal to twice the rate of growth of consumption. A straightforward calculation shows that mitigation is better than business as usual – that is, the present value of the benefits exceeds the present value of the costs – for any social rate of time preference less than 8.5%. No estimate of the pure rate of time preference, even by those who believe in relatively strong discounting of the future, has ever approached 8.5%.

History Note: Chico Plane Hijacked to Arkansas

My home, Chico, California, is not often seen as the center of the world, but we do have some distinctions. For example, the first airline hijacking on US soil occurred here. It may also be the only time that anyone ever hijacked a plane to Arkansas.

http://blogs.ocweekly.com/navelgazing/main/another-california-first-hijac/

Blood for Oil in Iraq Achieved! Now We Can Come Home!

Great news! As of this past week or so, for the first time oil production in Iraq has exceeded what it was under Saddam Hussein before the US invaded, a whopping 2.3 million
barrels per day!! For a country with the world's second largest oil reserves, this is a great achievement!!! Clearly, our goal there has been achieved, so now our troops can come home!!!

Radio Interview Today

I was interviewed today on KPFK Los Angles on Ian Masters' Background Briefing for the last 20 minutes of his show. I did not get to discuss the Confiscation of American Prosperity very much because the publisher neglected to send him a copy.

http://64.27.15.184/parchive/mp3/kpfk_071216_110100bbriefing.mp3

Transfer Pricing Enforcement in China- the IRS Should Be Paying Attention!

On my long list of statements from tax officials that strike me as incredibly short sighted comes this:

The China's State Administration of Taxation, emboldened by the Internal Revenue Service's result in the GlaxoSmithKline case, is directing its auditors in appropriate marketing intangibles cases to apply the residual profit split method to recompute royalty income.

The IRS was indeed very successful in arguing that some of the profits that British based Glaxo made on US sales of Zantac were attributable to the marketing efforts of Glaxo’s US subsidiary. But mind you that the tax planners for US based pharmaceutical companies with foreign marketing subsidiaries took notice of the IRS theory to successfully argue that some of the profits from US created drugs belonged offshore under arm’s length pricing. So if the Chinese are about to argue that distribution subsidiaries deserve a large share of the profits – wouldn’t this hold for US entities distributing products manufactured in China. Last year – the US exported only $55 billion of goods and services to China, while China sold almost $288 billion in goods in services to the US. Unless there existed no intangible profits from Chinese exports to the US and there were substantial intangible profits when US manufacturers sold goods to the Chinese, something tells me that China's State Administration of Taxation could come up with the short end of this stick.

It would seem that the Indian tax authorities successfully made a similar argument in a tax dispute with Rolls Royce. If this argument is turned on US based companies selling into India, let’s keep in mind that the India exports twice as much to the US as we export to them. With the US as a net importer of goods, any argument that the local distributor deserves a large slice of the profits is something the IRS should look forward to making in a bilateral way!

how does Mankiw's right differ from liberals and the left?

Wednesday, December 12, 2007 [by Greg "I worked for Dubya" Mankiw]

How do the right and left differ?

The conclusion of today's ec 10 lecture:

In today's lecture, I have discussed a number of reasons that right-leaning and left-leaning economists differ in their policy views, even though they share an intellectual framework for analysis. Here is a summary. [I replaced his asterisks with "GM," while my comments are labelled "JD."]

JD: first of all, I should note that Mankiw is only talking about one dimension of the political spectrum. I'd define left vs. right in terms of class, with the left siding with the poor and working classes and the right siding with Mankiw's employers. This left vs. right mostly coincides with democracy vs. dictatorship. There's also a centralized vs. decentralized spectrum, which is what Mankiw mostly describes. Finally, there's the tradition vs. modernism spectrum.

GM: The right sees large deadweight losses associated with taxation and, therefore, is worried about the growth of government as a share in the economy. The left sees smaller elasticities of supply and demand and, therefore, is less worried about the distortionary effect of taxes.

JD: Mankiw implicitly assumes that taxes "distort" markets, i.e., that the markets were "perfect" ahead of time. He assumes, for example, that no deadweight loss arises from the business sector. But even in the simplest neoclassical theory, it can do so: monopolies and monopsonies impose deadweight losses.

GM: The right sees externalities as an occasional market failure that calls for government intervention, but sees this as relatively rare exception to the general rule that markets lead to efficient allocations. The left sees externalities as more pervasive.

JD: This might be right, i.e. that the difference is empirically-based. But it should be mentioned that the right also likes to use methodological fiat to rule out the role of an important class of externalities, the pecuniary ones. They'd like to ignore such events as towns being destroyed economically when the major employer shuts down its operations, along with the Keynesian multiplier effect and the like.

GM: The right sees competition as a pervasive feature of the economy and market power as typically limited both in magnitude and duration. The left sees large corporations with substantial degrees of monopoly power that need to be checked by active antitrust policy.

JD: This defines the "left" as antitrust liberals. It ignores those of us who want to replace the capitalist monopoly on political power (unless we make a big noise) with real democracy, both in politics and in the economy.

GM: The right sees people as largely rational, doing the best the can given the constraints they face. The left sees people making systematic errors and believe that it is the government role’s to protect people from their own mistakes.

JD: The right's notion of "rationality" is close to tautological: rationality involves people doing what they want to do. Individual preferences are taken for granted and unexplained. A heroin addict is "rational" according to the right-wing economists. Further, "rationality" is totally an individual thing that can be expressed only in markets. This forgets the role of social values, which typically cannot be expressed through markets (no matter how rational they are) but can be expressed via democracy.

GM: The right sees government as a terribly inefficient mechanism for allocating resources, subject to special-interest politics at best and rampant corruption at worst. The left sees government as the main institution that can counterbalance the effects of the all-too-powerful marketplace.

JD: Again, this "left" is the liberals. It ignores the left which wants to end the artificial distinction between the state (government) and the "market" and to subordinate both of these to democracy.

GM: There is one last issue that divides the right and the left -- perhaps the most important one. That concerns the issue of income distribution. Is the market-based distribution of income fair or unfair, and if unfair, what should the government do about it? That is such a big topic that I will devote the entire next lecture to it.

JD: Is it a "market-based distribution of income"? Not according to the standard economics which Mankiw professes to profess. Standard neoclassical economics starts with the distribution of _assets_. Then the market results reflect that distribution (along with differences in preferences).

At this point, we should bring in non-standard economics: those with the most assets benefit most from the market. This allows them to accumulate more assets, so that they benefit even more from the market.

This kind of snowballing inequality of asset-ownership (and power) can be seen happening during the last 27 or so years of US economic history. This is now being admitted by mainstream economists. See the interview with Frank Levy in the current issue of CHALLENGE.

Jim Devine / "The conventional view serves to protect us from the painful job of thinking." -- John Kenneth Galbraith

Now that's a free ride!

It's that time of year again, time to make the donuts....er, grade final exams. I had a question on the Principles exam asking whether a tunafish entrepreneur - Charley "The Tuna" Sharkspear by name - who knew that consumers value safe dolphins more than the added cost of fishing in a dolphin-safe fashion could make money providing the dolphin-safe tuna. The idea I wanted them to get was that the safety of the dolphins, if accomplished, is a public good. From one student I learn that:

"People will continue to buy a cheaper tuna and still 'free-ride' on the dolphins that Charley is saving."

That sounds like fun. Back to work!

CNN Caught Mimicking Faux News with Iran Nuclear Weapons "Speculative Documentary"

CNN was to air today a "speculative documentary" entitled "We Were Warned - Iran Goes Nuclear" with actors playing real officials and hyperventilating on the now discredited non-data about Iran's nonexistent nuclear weapons program. The program has been postponed for now, given the recent NIE report. This shows how CNN has been under pressure to imitate the war hysteria of Faux News. An old friend of mine, who is quite progressive, was involved in helping make this, and had been bamboozled by briefings from unnamed national security officials. Details on this story are available from Bill Gallagher at http://www.niagarafallsreporter.com/gallagher344.html, and if this is not right, you can find it by linking through today's posting by Juan Cole.

Credit Crunch and Sudden Stop: Can We Avoid a Perfect Financial Storm?

Credit markets are all a-jitter again. No one knows how many assets will be nonperforming, which ones they will be, how much total value is at stake. We also know that there has a been a sudden stop, a complete cessation of net long-term private capital inflows to the US; nearly all of the financing burden of the US current account deficit has to be shouldered by central banks and sovereign wealth funds. These two events are related.



It is US debt, mortgage items but perhaps not only, whose quality is in doubt. This is why there is little appetite for such goodies among private investors. But if enough liquidity is pumped in to dissuade investors from wholesale dumping, and if the CB’s continue to do what it takes to keep the dollar afloat, we may continue to muddle through.

The risk is that the two dangers will interact. The Fed and its partners can support asset values by buying into these markets, as they have indicated they will. But if for any reason this effort falls short, it is possible that default risk and currency risk could spiral upward in tandem. Fear of default could push private capital flows into the red; this would ramp up the pressure on the dollar, increasing currency risk, and so on. It is not beyond the realm of the possible that this nasty synergy could erupt within the time frame of a few hours or even minutes. It would be sudden and unexpected: one morning you could go online to scan the headlines and find out we were already in the thick of it.

I’m not saying that a crisis is inevitable, but I’m not saying it can’t happen either.

All We Are Saying is Give Peace a Chance

My view on Iraq was: (a) we never should have started this stupid war, and (b) once we did, we should have declared victory and come home a long time ago. For those who get their “news” from Faux News, it would seem the Iraq war is no more. And now David Brooks says we’ve gotten past this idiotic episode as well:

But the more comprehensive difference between a wartime election and a postwar election is that there is a shift in values. In wartime, leadership traits like courage, steadfastness and ruthlessness are prized. Voters are willing to vote for candidates they distrust so long as they seem tough and effective (Hillary Clinton, Rudy Giuliani). In a postwar election things are different. When Wall Street Journal/NBC pollsters asked voters what qualities they were looking for in the next leader, their top three choices were: the ability to work well with leaders of other countries; having strong moral and family values; bringing unity to the country. Those are cooperative qualities, not combative ones. They require good listening skills, openness and the ability to compromise.

Including the title, I counted five instances where Mr. Brooks used the word “postwar”. There is only one problem, which Greg Mitchell articulates:

Postwar? Peace? Try telling that to the soldiers in Iraq, and the families whose kids are still coming home minus a limb or part of their brain. Last I checked we were still spending billions of dollars a month Over There and I haven't heard about any bases, or the grand embassy, being dismantled. A new Gallup poll (see below) disputes the notion, anyway. Is the issue a little less "hot"? Surely. But to say it is over is an obscenity. With rose-colored glasses still in place, Brooks takes a world tour, finding more reason to relax about Iran, Pakistan (?), even the Palestinian question. My favorite line then follows: "The world still has its problems." Gosh, you think? Later he admits, "Something terrible could happen in the world" to change the hopeful mood. As if little terrible is happening now. This all started last week with Peter Beinart’s self-serving column in The Washington Post -- Brooks cites it today -- which flatly called the war a "non-story." He took as his main evidence that questions about the war were not being asked all that much at the Democratic and Republican debates. The fact that all of the Democrats are much in agreement against the war, and all of the leading Republicans in agreement in support of the venture, apparently did not occur to Beinart as an explanation. Of course, if any of the Democrats faced off against any of the Republicans right now, is there any doubt what would be the hottest issue? But Beinart – an original hawk on the war, like Brooks – had good reason to downplay the disaster he helped cause.

Hawks like Brooks and Beinart were over-hyping the treat of Saddam Hussein as they underestimated the potential costs of invading Iraq back in 2002 and early 2003. So why is Greg surprised that these pundits are at it again with their dismissing the fact that this failed and very destructive adventure continues? Brooks does have not the courage to do what Paul Harvey did in 1970 when Mr. Harvey told President Nixon that the Vietnam War was a mistake that should be ended immediately. As a kid, I had to endure the fact that my parents made me watch Mr. Harvey’s conservative rants on a daily basis. As an adult, I miss the old fashion conservatives. No, having to endure hacks like David Brooks is so much worse.

Where Does John Edwards Stand on Social Security?

Barkley accuses John Edwards of drinking the Kool Aid, while Phillip Elliot praises Mr. Edwards for “real leadership” thusly:

Democrat John Edwards yesterday criticized rival Hillary Rodham Clinton, saying candidates who seek the White House should take strong, clear stands on difficult issues like Social Security. Clinton has said she doesn't want to put forward a specific plan now to shore up Social Security, but would wait for recommendations from a bipartisan commission because any plan will need the support of Democrats and Republicans to be enacted. Asked about her stance at an AARP-Divided We Fail lunch on health and financial security, Edwards told seniors: "If you want to be President of the United States, you should lead. Leadership means taking clear, strong positions for the American people. ... I've said very clearly what I would do, not said I'm going to wait and figure this out later."

The last quip seems to confirm Barkley’s suggestion that Mr. Edwards has fallen for the GOP spin that the Social Security system is in imminent danger. We in more of an imminent danger of a mushroom cloud over Manhattan from an Iran nuke that a Social Security meltdown.

But I’m going to try to be fair to Mr. Edwards by asking what he means by this alleged very clear statement of what he would do. It would seem his policy position is basically status quo with the exception that he’d lift the payroll caps. That’s it! And Phillip Elliot calls this leadership? Fine – Senator Clinton hasn’t exactly stated where she’d change the status quo either. OK, the GOP debates are incredibly stupid on just about every issue- but if this is all we Democrats have got, maybe I should go back to watching my Atlanta Falcons pretend to pay football. Ho-hum!

But to be fair – I’m sort of a status quo bear when it comes to this issue. Next topic – please?

Is Kos Drinking Social Security Kool Aid?

Continuing an old tradition from Maxspeak, let me dump on Daily Kos. I just noticed a long post there about "leadership" among Dems and Dem candidates in particular. Much of it was anti-Hillary and mostly focused on her war views. On those, I join in criticizing her. However, this "lacking leadership" is the line being handed out previously by Obama and more recently very loudly by Edwards in attacking her on not proposing changes to social security. I confess that I am not sure what Kos's views on social security are, but at least rhetorically, he, or they, are adding to the rhetoric of those who have drunk the kool aid of "Social Security is in Crisis and we must do Something!"

thoughts on the Prisoner's dilemma.

While trying to teach my students about the (non-repeated) "Prisoner's Dilemma" (PD) game, I had the following thoughts. I hope some of them are vaguely original -- or at least interesting.

The usual view of this "game" is that it turns Adam Smith's "Invisible Hand" (IH) on its head (or on its heel). In the Greatest Economics Story Ever Told, the IH says that in exchange, individual greed leads to the production of mutually-beneficial gains for all (or almost all) people, especially when organized by a competitive market. On the other hand, in the PD story, individual greed (possessive individualism) leads to mutual destruction of the prisoners. This occurs even though there exists a mutually-advantageous solution for them (collusion, cooperation, conspiracy, other "c" words).

There's another way of looking at the PD. The problem is that the police have set up a special social structure that pushes the prisoners to hurt each other. They aren't allowed to talk to each other. They have to make their decisions (rat[*] on each other or keep quiet) simultaneously (in effect). The cops create incentives that push each prisoner to rat. Thus, the prisoners both "defect" and suffer.

(For simplicity, I'm ignoring degrees between "ratting" and "staying mum." I'm also ignoring the honor among thieves, which can encourage tacit collusion, so that both refuse to "rat" on the other.)

This might be thought of in terms of "transactions costs" which make it extremely expensive for the prisoners to get together and strike a deal. But that would be misleading.

The problem is that exchange can also be like a PD game. Orthodox economists don't tell you that in the act of exchange, the two "players" are colluding to not rob each other. If we drop this usually-covert assumption, we see four possible choices. (Again, the choice is binary, ignoring intermediate choices between the extremes. Again, the two "traders" are assumed to embrace possessive individualism.)

1. Cain and Abel swap their goods with each other, with mutually-beneficial effects (collusion, IH result).

2. Cain slays Abel, stealing his goods. Cain gains in a big way (getting both sets of goods) while Abel obviously suffers.

3. Abel slays Cain, reversing the roles.

4. Both fire their weapons at each other, so both die (both defect, the usual PD result).

As in a PD game, the incentive is there for Cain to kill Abel. Naturally, Abel will fear this event and find that he has an incentive to preempt Cain's dirty deed (done dirt cheap). So Cain may react by shooting first. Mutual destruction ensues...

What's the solution to this mess? Orthodox economics (Orthonomics?) simply assume it away. More seriously, the English political philosopher Thomas Hobbes advocated bringing a very Visible Hand, the Leviathan, the unified state which monopolizes the means of violence. This prevents mutual destruction. It sets up incentives for the two traders to cooperate.

Another English political philosopher, John Locke, naturally enough didn't trust the state. His solution was to advocate merging the propertied class (what we would call the capitalists) with the state. The former should dominate the latter, to the maximal possible extent, natch. In this scenario, Cain and Abel _are_ the state, colluding to prevent the odious option #4.

An incentive problem still exists, however. Suppose that we see trading between the two brothers. Cain could see the benefits of having both of the guys' goods rather than simply getting Abel's goods in exchange for his own. He might then cheat or rob or kill Abel. This unhinges the collusion (or turns the game into a one-person affair, which I'll ignore).

But Locke had a solution: he proposed that people accept each others' property rights as "natural." If they accept this fiat, then trading can occur and both can benefit. It's as if he were proposing that the "honor among thieves" that allows real-world prisoners to collude in real-world dilemmas should apply to all property owners. They should see themselves as a community, with common interests.

Though Hobbes and Locke were a little silly (seeing imaginary "social contracts" as providing insight into what's happening in the real world), they captured the two main elements of what allows the IH to work, at least some of the time. These are the coercion of the state and the generally-accepted legitimacy of property rights.

The latter element, I believe, needs a lot of shoring up. After all, if profits are to be made, why accept the ideology of "natural" property rights? But there are two reinforcing elements that Karl Marx might suggest. The property owners cling to the ideology of natural property rights because it unites them against those who lack significant property rights (capital). The ideology helps maintain ruling-class solidarity. Second, if the capitalists believe it, or at least generally act as if they did, then it's easier to teach to the underclasses.

This analysis says that the mutually-beneficial exchange of the IH story is just as artificial as is the mutual destruction of the PD case. Both are based in human-made institutions. For one, the IH, the structure is created allowing collusion, while for the other, the PD, it's set up to encourage defection.

Those in power decide which activities fit in which box. For example, for you hemp-heads out there, the capitalist state in the US has decided that pot sellers belong in the PD box, while alcohol purveyors belong in the IH box.

To choose a less heady example, the social structure puts purely private goods in the IH box, while purely public goods are in the PD box. (The "public goods problem" is a version of the PD game, with a large number of participants. The "rats" are called free-riders.) Of course, in the real world, almost no products are purely public or purely private.

BTW, if this story is revealing, that indicates (once again) that game theory can say something about the world, as long as we don't obsess with equilibrium situations (Nash or otherwise).

[*] This is unfair to rats. Recent research indicates that those cute and furry creatures are more cooperatively-minded than the stereotypes say.
--
Jim Devine

The Death Grip of Savings Mania on Mainstream Democrats

Bob Frank is a smart guy with progressive instincts. His take on economic policy today is probably what we will see in a Democratic administration in 2009. That’s why it’s worth pointing out that the conventional wisdom he channels is politically and intellectually bankrupt.



He wants us to raise taxes because of “the deficits”, conflating the government’s fiscal deficit with the country’s current account deficit. Aside from sewing the sort of confusion that educators should be pledged to dispel, this argument recycles the discredited “twin deficits” hypothesis of the 1990's. Our external deficit, according to this view, is the product of our lack of savings, particularly public savings. (The fiscal deficit is a deduction from our national savings account.)

Been there, disconfirmed that. Over the course of the 90s the fiscal balance went from negative to positive, but the current account balance went down, down, down. Here’s how it looked:



Both the fiscal and current account balances are expressed as percentages of GDP, with bigger deficits pushing south. Except for a few years in the early 2000's, the two balances move in opposite directions. Shrink the government deficit (or squeeze out a surplus) and watch the current account drop. Of course, simple correlations like this are just the beginning of the story, but even fancy manipulations don’t turn this negative relationship into a positive one.

As I’ve argued before and at greater length, while everything affects everything else, the current account determines savings to a far greater extent than the other way around. The trade deficit is a drag on incomes, made up by the borrowing we do when the money comes back to us in the capital account. That transmission mechanism is obvious and visible. What about the effects of savings on trade?

There are only two routes. Either low savings leads to higher GDP (Keynes) and therefore a higher trade deficit, or it raises interest rates, which boosts the value of the dollar, which feeds the trade deficit. The first is empirically marginal at the present time: the US trade deficit is not driven by faster growth rates here compared to abroad. Even if it were otherwise, fixing trade by inducing a recession is curing a disease by killing the patient. The second route is counterfactual at two crucial points: domestic savings (low) do not drive interest rates (low) in the US, and interest rates do not drive the value of the dollar. Both are controverted by the willingness of foreign central banks and sovereign investment funds to buy dollar assets, thus far without limit.

So there is no compelling economic argument for obsessing on savings.

The political case is even weaker. The Democrats have become the party of sacrifice. They worry about Social Security (yes, that’s mentioned in Frank) because it will become a net draw on savings ten years out, so we have to “fix” it. We have to raise taxes because the fiscal deficit (currently within the Maastrict limit imposed on the Eurozone) is bad for savings. It’s all about savings, and it’s all wrong.

My suggestions: (1) Deal with the current account directly. If we cannot get international cooperation on the dollar, create a system of tradeable import permits. Take urgent action to cut the demand for petroleum, good for our trade balance and the earth’s carbon balance. Take an honest look at industrial policy. (2) Accept a fiscal deficit of 2-3% of GDP, as long as it makes sense as a national income stimulant, and as long as a substantial portion of public spending goes to investment in people and technology. (3) Finance large increases in public investment and energy transition by drastically cutting military spending. With a more modest military we could make more alliances, fewer wars and enjoy greater true security.

Pharmaceutical Crackup?

The Wall Street Journal has a great article about the big players in the pharmaceutical industry, showing how it is dealing with its lack of progress in developing new drugs -- by more intensive marketing, taking over smaller, more innovative companies, and laying off workers. Even so, Wall Street is looking forward to lower profits. Here is the article & another on the layoffs.



Martinez, Barbara and Jacob Goldstein. 2007. "Big Pharma Faces Grim Prognosis: Industry Fails to Find New Drugs to Replace Wonders Like Lipitor." Wall Street Journal (6 December): p. A 1.

"Over the next few years, the pharmaceutical business will hit a wall. Some of the top-selling drugs in industry history will become history as patent protections expire, allowing generics to rush in at much-lower prices. Generic competition is expected to wipe $67 billion from top companies' annual U.S. sales between 2007 and 2012 as more than three dozen drugs lose patent protection. That is roughly half of the companies' combined 2007 U.S. sales."

"At the same time, the industry's science engine has stalled. The century-old approach of finding chemicals to treat diseases is producing fewer and fewer drugs. Especially lacking are new blockbusters to replace old ones like Lipitor, Plavix and Zyprexa."

"The coming sales decline may signal the end of a once-revered way of doing business. "I think the industry is doomed if we don't change," says Sidney Taurel, chairman of Eli Lilly & Co. Just yesterday, Bristol-Myers Squibb Co. announced plans to cut 10% of its work force, or about 4,300 jobs, and close or sell about half of its 27 manufacturing plants by 2010."

"Between 2011 and 2012, annual industry revenue will decline, estimates Datamonitor, a research and consulting firm. That would be the first decline in at least four decades.'

"Once it hits the market, however, the patent-protected drug is highly profitable: Typical gross margins are 90% to 95%.'

"The rise of generics wouldn't matter so much if research labs were creating a stream of new hits. But that isn't happening. During the five years from 2002 through 2006, the industry brought to market 43% fewer new chemical-based drugs than in the last five years of the 1990s, despite more than doubling research-and-development spending."

""There haven't been any new therapies that are proven to reduce death and disability for atherosclerosis since the introduction of the [cholesterol-lowering] statins" in the late 1980s, said Richard C. Pasternak, vice president of Cardiovascular Clinical Research at Merck. Atherosclerosis, a buildup of arterial plaque, is a major cause of heart disease."

"Biotech drugs are especially appealing because they face no competition from generics: No regulatory pathway yet exists in the U.S. for bringing to market generic biotech drugs. So until Congress creates such a pathway, no generic threat will exist to the $4,400 a month that Genentech Inc. charges for its cancer drug Avastin, or the $200,000 a year that Genzyme Corp. gets for Cerezyme to treat Gaucher disease. And biotechnology products tend to target specialized areas of medicine that don't require mass advertising or armies of salespeople."

"So big pharmaceutical companies have spent nearly $76 billion since 2005 to buy biotech companies, according to Health Care M&A Information Service, a unit of Irving Levin Associates Inc., a Norwalk, Conn., research company. While in 2005 there were 33 deals amounting to $16.5 billion, in the first nine months of this year there were 49 deals totaling $28.7 billion, including AstraZeneca PLC's $15.6 billion acquisition of MedImmune, which followed a bidding war against Eli Lilly, among others."

"The dearth of new products has led the industry to invest heavily in marketing and legal tactics that squeeze as much revenue as possible out of existing products. Companies have raised prices; the average price per pill has risen 63% since 2002, according to Michael Krensavage, Raymond James analyst. Companies raised advertising spending to $5.3 billion in 2006 from $2.5 billion in 2001 and since 1995 have nearly tripled the number of industry sales representatives to 100,000."

"The industry spent $155 million on lobbying from January 2005 to June 2006, according to the Center for Public Integrity, on "a variety of issues ranging from protecting lucrative drug patents to keeping lower-priced Canadian drugs from being imported." The industry also successfully lobbied against allowing the federal government to negotiate Medicare drug prices, the center said. The lobbying has drawn fire from politicians, doctors and payers, and damaged the industry's public image."

==========

Loftus, Peter and Sarah Rubenstein. 2007. "Bristol-Myers Cuts Jobs, Plants to Shore Up Profit." Wall Street Journal (6 December): p. D 6.

"Bristol-Myers Squibb Co. is the latest big pharmaceutical company to announce a restructuring in the face of looming generic competition and pipelines with few potential blockbusters. The New York drug maker said it will cut its work force by 10%, or about 4,300 jobs, and close or sell about half of its 27 manufacturing plants in a plan to save about $1.5 billion by 2010 and boost profitability."

"Bristol-Myers Chief Executive James Cornelius told investors that the company faces a "patent cliff" early next decade, when its popular antiblood-clotting drug Plavix will lose U.S. market exclusivity."