What Drives Innovation?
Lessons from COVID-19 Research and Development
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International Monetary Fund. Research Dept.
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Ruchir Agarwal

Abstract

Ruchir Agarwal

Ruchir Agarwal

ragarwal@IMF.org

Patrick Gaule

patrickgaule@gmail.com

The COVID-19 pandemic is one of the greatest challenges ever faced by modern medicine. When China publicly shared the genetic sequence of the novel coronavirus on January 12, 2020, scientists quickly began working on vaccines and treatments to fight SARS-CoV-2. The odds for quick success looked dim. On the vaccine front, the fastest any vaccine had previously been developed was in four years-for mumps in the 1960s-and thus even predictions of success by summer 2021 seemed highly optimistic. On the treatment front, limited progress had been made on the other known coronaviruses that cause disease in humans despite decades of research.

The scientifc community responded with a massive research and development (R&D) effort. By December 2020, several vaccine candidates had excellent results in large trials, with two (developed by Pfzer/BionTech and Moderna) receiving emergency use authorization in several countries. Researchers had also identified various treatments that could modestly reduce mortality. While major challenges remain in scaling up the production and distribution of vaccines and tackling the new virus strains, the pharmaceutical innovation response to COVID-19 has already turned out to be an unprecedented success in terms of product discovery and development.

The COVID-19 experience demonstrates that drug development can potentially proceed rapidly—without compromising safety—when there is a global emergency and there are sufficient resources available for R&D. This raises the question, What lessons can we draw from the response to COVID-19 about the drivers of innovation, and how can it inform the global effort to scale up the fight against other deadly diseases and other challenges, such as climate change?

Recent IMF research sheds light on this question by examining how the entire landscape of clinical trials changed in response to the large discrete shift in global medical needs—and thus the market size for pharmaceutical products—brought about by COVID-19. Four key takeaways emerge.

First, R&D efforts typically do not increase one to one as a disease becomes “bigger.” The cross-sectional relationship between the market size of a disease (measured as the disease-level mortality risk at the national level weighted by national income levels) and R&D effort (measured as new clinical trials) is established by matching data on worldwide clinical trials to 75 broad disease categories with a non-negligible death burden. The estimated elasticity— how much R&D effort increases when market size increases—is strictly less than 1 (about 0.5) across all disease categories and also within subcategories (such as cancer or infectious diseases). Put simply, R&D effort put into fighting a disease increases less than the market size of that disease. We call this relationship the “law of diminishing effort.”

Second, the R&D response to COVID-19 is a major exception to this law: the number of COVID-19 trials is 7 to 20 times greater than what is implied by the historical relationship between market size and R&D effort.

Third, the R&D response to COVID-19 suggests that global innovation can be scaled up rapidly and sizably. That is, even in the short term, the aggregate supply elasticity of science and innovation can be very large. In the initial months of the pandemic, up to 50 percent of new trials were directed toward COVID-19. And, despite the large increase in COVID-19 R&D, overall new clinical trials rose by 38 percent in 2020, with little crowding out of R&D effort for other diseases.

Fourth, public research institutions were a key driver of the COVID-19 R&D effort—accounting for 70 percent of all COVID-19 clinical trials globally. These public institutions were 10 percentage points more likely to conduct a COVID-19 trial than private firms. In addition, US and Chinese vaccine candidates were on average developed two months faster than candidates from other countries. This crucial boost in speed may have resulted from more early-stage incentives from the policy response in these countries, including through programs such as Operation Warp Speed in the United States that funded clinical trials and manufacturing capacity for various vaccine candidates. Last but not least, several important COVID-19 pharmaceutical innovations were driven by public research institutions with no explicit monetary incentives—suggesting the role of intrinsic motivation and altruism among researchers. For instance, several key treatment findings came from university labs during publicly funded clinical trials—with no obvious monetary benefits (for example, the National Institute of Health Research funded a clinical trial on dexamethasone).

This research hopes to inform ongoing work in innovation economics. Even after six decades of active research since a seminal 1960 National Bureau of Economic Research conference, The Rate and Direction of Inventive Activity, many notable questions in innovation economics remain open. In this context, there are three broad implications for the future of innovation economics.

Market size alone may not suffice

Simply boosting the market size of pharmaceutical products (for example, through commitments to pay more for successful innovations) may not effectively scale up innovation to fight major diseases-given the law of diminishing effort. The diminishing effort effect blunts the effectiveness of the classic market size incentives favored in economics. The law of diminishing effort could arise because of various mechanisms, such as (1) decreasing returns to scale as a result of a scarcity of ideas or talent, (2) risk aversion among firms’ management, and (3) disease-specific ex post taxation (what we call the “paradox of market size”). Future research should investigate the relative importance of these mechanisms and examine whether these factors lead to market inefficiencies.

Public sector helps the invisible hand

Public research institutions, government-led incentives, and nonmonetary incentives drive innovation. Current thinking in the economics profession is still dominated by a perspective that innovation is driven by private sector market-size factors. Consistent with a widespread belief in the economics profession and among policymakers, enhancing market size has been seen as key to accelerated COVID-19 innovation. For instance, in a survey of prominent economists conducted by the University of Chicago Initiative on Global Markets on June 23, 2020, the questions were focused on how much acceleration in COVID-19 innovation could be achieved by enhancing the market size; meanwhile early-stage incentives and the role of the public sector were not even considered.

The COVID-19 experience invites us to rethink the role of public research institutions and the catalyzing role of governments in promoting innovation for the greater good. Various factors played a role in the innovation success-including an intrinsic pursuit of the greater good by many in the global scientific community, past experience with related virus pathogens, and better manufacturing technology-but government-led incentives and funding played an important role in the success story.

Scope to significantly scale up global innovation

The rapid and large R&D response to COVID-19 raises the distinct possibility of scaling up global innovation to fight future challenges-including other deadly diseases and climate change. However, scaling up global innovation may require a more active role by governments in providing early-stage R&D incentives. Policymakers may also need to gain better understanding and eliminate barriers that currently prevent researchers from harnessing their intrinsic motivation to scale up research during normal times. Such measures are likely to be complementary to other efforts to advance the global knowledge frontier, such as policy measures to increase the quality of human capital.

Economists are naturally in favor of market size as a driving force for innovation. (“If the market size of the product is sufficiently large, then innovation will happen.”) This research suggests, however, that enhancing market size alone may not be an effective pull when it comes to driving innovation in the face of large challenges. Policymakers may want to complement the market size effect with early-stage incentives and by harnessing the power of public research institutions and nonmonetary incentives.

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