The discussion so far on cost disease seems pretty inadequate, and I think a key piece that's missing is the concept of Hollywood Accounting. Hollywood Accounting is what happens when you have something that's extremely profitable, but which has an incentive to not be profitable on paper. The traditional example, which inspired the name, is when a movie studio signs a contract with an actor to share a percentage of profits; in that case, the studio will create subsidiaries, pay all the profits to the subsidiaries, and then declare that the studio itself (which signed the profit-sharing agreement) has no profits to give.

In the public contracting sector, you have firms signing cost-plus contracts, which are similar; the contract requires that profits don't exceed a threshold, so they get converted into payments to de-facto-but-not-de-jure subsidiaries, favors, and other concealed forms. Sometimes this involves large dead-weight losses, but the losses are not the point, and are not the cause of the high price.

In medicine, there are occasionally articles which try to figure out where all the money is going in the US medical system; they tend to look at one piece, conclude that that piece isn't very profitable so it can't be responsible, and move on. I suspect this is what's going on with the cost of clinical trials, for example; they aren't any more expensive than they used to be, they just get allocated a share of the profits from R&D ventures that're highly profitable overall.

4Elizabeth1yDid you mean "allocated a share of the costs"? If not, I am confused by that sentence.
4jimrandomh1yI'm pretty uncertain how the arrangements actually work in practice, but one possible arrangement is: You have two organizations, one of which is a traditional pharmaceutical company with the patent for an untested drug, and one of which is a contract research organization. The pharma company pays the contract research organization to conduct a clinical trial, and reports the amount it paid as the cost of the trial. They have common knowledge of the chance of success, of the future probability distribution of future revenue for the drug, how much it costs to conduct the trial, and how much it costs to insure away the risks. So the amount the first company pays to the second is the costs of the trial, plus a share of the expected profit. Pharma companies making above-market returns are subject to political attack from angry patients, but contract research organizations aren't. So if you control both of these organizations, you would choose to allocate all of the profits to the second organization, so you can defend yourself from claims of gouging by pleading poverty.

Ah, that makes sense. Thanks for explaining.

Jimrandomh's Shortform

by jimrandomh 1 min read4th Jul 201964 comments

This post is a container for my short-form writing. See this post for meta-level discussion about shortform as an upcoming site feature.