Has pharmaceutical innovation reduced the average cost of U.S. health care episodes?

A number of authors have argued that technological innovation has increased U.S. health care spending. We investigate the impact that pharmaceutical innovation had on the average cost of U.S. health care episodes during the period 2000-2014, using data from the Bureau of Economic Analysis' Health Care Satellite Account and other sources. We analyze the relationship across approximately 200 diseases between the growth in the number of drugs that have been approved to treat the disease and the subsequent growth in the mean amount spent per episode of care, controlling for the growth in the number of episodes and other factors. Our estimates indicate that mean episode cost is not significantly related to the number of drugs ever approved 0-4 years before, but it is significantly inversely related to the number of drugs ever approved 5-20 years before. This delay is consistent with the fact (which we document) that utilization of a drug is relatively low during the first few years after it was approved, and that some drugs may have to be consumed for several years to have their maximum impact on treatment cost. Our estimates of the effect of pharmaceutical innovation on the average cost of health care episodes are quite insensitive to the weights used and to whether we control for 3 covariates. Our most conservative estimates imply that the drugs approved during 1986-1999 reduced mean episode cost by 4.7%, and that the drugs approved during 1996-2009 reduced mean episode cost by 2.1%. If drug approvals did not affect the number of episodes, the drugs approved during 1986-1999 would have reduced 2014 medical expenditure by about $93 billion. However, drug approvals may have affected the number, as well as the average cost, of episodes. We also estimate models of hospital utilization. The number of hospital days is significantly inversely related to the number of drugs ever approved 10-19 years before, controlling for the number of disease episodes. Our estimates imply that the drugs approved during 1984-1997 reduced the number of hospital days by 10.5%. The hospital cost reduction was larger than expenditure on the drugs.