Pharma vs endogenous growth

Is endogenous growth theory right? This is the question raised by the news that GW Pharma's share price has fallen sharply after its Sativex drug failed to beat a placebo in phase III trials - though in fairness, placebos can be powerful things. 
This shows just how hard it is to bring new drugs to market; it follows disappointment with Renovo's Juvista.
For this reason, the stock market has a downer on pharmaceuticals generally, especially smaller ones. The Aim healthcare sector has fallen by half relative to the All-share in the last four years, as investors fear companies will burn cash in the fruitless pursuit of new drugs.
Conventional economics predicts this should happen, because there are diminishing returns to drug research. Companies pick the low hanging fruit first - the easily discovered drugs - but once they've done this they have to spend more and more money to lesser products unless they get lucky.
And this is where endogenous growth theory comes in. In some forms, it denies that diminishing returns are so powerful. Instead, it says, success can breed success, as  breakthroughs in technology lead to other breakthroughs.
However, the experience of GW Pharma and Renovo - and investors' opinion of pharmaceuticals generally - suggests growth, at least in biotech for now, isn't so endogenous and that diminishing returns are hard to avoid after all.
So, is the market wrong, or is endogenous growth theory not all it's cracked up to be?

Comments

[Tim Worstall]

"Instead, it says, success can breed success, as breakthroughs in technology lead to other breakthroughs."

I've no brief for endogenous (or even neo-endogenous) growth theory but in your description an awful lot hangs on the value of "can".
The discovery of a way to cure any viral disease (absolutely any at all: all we can do at present is treat some symptoms of some of them, vaccinate against others) would, it could be argued, be a time when "can" mean "will".
But of course "can" also encompases the meaning of might, but not this time, as perhaps above.

[JH]

I can't recall my old university theory but I thought that endogenous growth encapsulated any of the three different growth possibilities (explosive, linear or diminishing). It depended upon the assumptions you made about the parameters in your production function.

It is only theory after all and I think it's strength was meant to be that it demonstrated accelerating returns weren't necessarily theoretically impossible.

Not sure how this relates to your point about pharma.

[reason]

I'm wondering how someone could deliberately create placebos and get them accepted in the market place. I suppose homeopathy is something like that. But no, this just confirms my view that scientific breakthroughs are often serendipidy and incentive has little to do with it. The secretiveness required of patent protection, however acts negatively on the cross-fertilisation of ideas that is part of progress. My view of IP can be at best described as guarded.

[Gerard O'Neill]

"In some forms, it denies that diminishing returns are so powerful. Instead, it says, success can breed success, as breakthroughs in technology lead to other breakthroughs."

I wonder if this particular 'form' is peculiar to the IT industry? There you can see how network effects create a positive feedback loop that truly is endogenous growth. But pharma might be like the energy sector: at some point you come up against 'barriers' (the boundaries of scientific knowledge, the laws of physics etc) that are, for the time being, insurmountable no matter how much money you throw at them.

In which case the AIM energy sector might just follow the healthcare sector in due course.

[Glenn (aka Angry Economist)]

The dilemma probably relates to neither diminishing returns or endog GT directly. Its more due to the corporate model of innovation in operation in the Pharma industry.

The reason why the pharmas are not recouping gains from innovation activities and that the breakthroughs do not spread throughout the economy are because they have an internal innovation system. Any novel processes or products that might have application beyond the pharma's area of specialism never get considered.

Lots of sectors now operate 'open innovation' systems - where there is more of an open market in innovation. e.g. some big corporations encourage spin out ventures, and even invest equity in them, for innovations outside of their core sphere of commercial interest but which have commercial potential. In open innovation, there is more buying-in of innovation too. e.g. large corps buying up small innovative enterprises.

in closed innovation systems - the endogenous growth potential is small. In open innovation systems it is high - because there is more scope for knowledge transfer, positive externalities, spillovers etc.