Consider the information in the readings on "Death by Bureaucrat", "Flying the Friendly Skies", and the podcast on "The Economics of Vaccine Pricing."1. Identify an example of (use a specific example from the readings and/orpodcast, not a general example):o a tradeoff/opportunity cost,o thinking at the margin, ando incentives.2. How do the incentives of the consumers, firms, and government differ inone of these cases?3. Provide a parallel between two of the three issues: drug safety, airlinesafety, and developing a vaccine. (In what way is there a similarity?)

CHAPTER 1 Death by Bureaucrat How would you rather die? From a lethal reaction to a drug prescribed by your doctor? Or because your doctor failed to prescribe a drug that would have saved your life? If this choice sounds like one you would rather not make, consider this: Employees of the Food and Drug Admin- istration (FDA) make that decision on behalf of millions of Americans many times each year. More precisely, FDA bureaucrats decide whether or not new medicines (prescription drugs) should be allowed to go on sale in the United States. If the FDA rules against a drug, physicians in America may not legally prescribe it, even if thousands of lives are being saved by the drug each year in other countries. A BRIEF HISTORY OF THE FDA The FDA's authority to make such decisions dates back to the passage of the Food and Drug Safety Act of 1906. The law required that medi- cines be correctly labeled as to their contents and that they not contain any substances harmful to consumers' health. Due to this legislation, Dr. Hostatter's Stomach Bitters and Kickapoo Indian Sagwa, along with numerous rum-laden concoctions, cocaine-based potions, and supposed anticancer remedies disappeared from druggists' shelves. The law was expanded in 1938 with the passage of the Food, Drug, and Cosmetic Act, which forced manufacturers to demonstrate the safety of new drugs before being allowed to offer them for sale. (This law was prompted by the deaths of 107 people who had taken Elixir Sulfanilamide, an anti- biotic that had been errantly mixed with poisonous diethylene glycol, a chemical cousin of antifreeze.)Death by Bureaucrat 7 + CHAPTER ONE 5. Things aren't always as they seem. Many analyses of the effects of The next step in U.S. drug regulation came after a spate of severe government policies take an approach that does not fully recognize birth defects among infants whose mothers during pregnancy had the actions that people would otherwise have taken. Thus, official taken a sleep aid known as thalidomide. When these birth defects first pronouncements about the effects of policies routinely misrepre became apparent, the drug was already widely used in Europe and Can- sent their impact-not because there is necessarily any attempt to ada, and the FDA was nearing approval for its use in America. In fact, deceive but because it is often difficult to know what would have about 2.5 million thalidomide tablets were already in the hands of U.S. happened otherwise. Pharmaceutical manufacturers, for example, physicians as samples. The FDA ordered all of the samples destroyed have strong incentives to avoid introducing drugs that are unsafe and prohibited the sale of the drug in the United States. This incident or ineffective because the companies are subject to loss of reputa- led to the 1962 Kefauver-Harris Amendments to the 1938 Food, Drug, tion and to lawsuits. For similar reasons, physicians have strong and Cosmetic Act, radically altering the drug-approval process in the incentives to avoid prescribing such drugs for their patients. Even without FDA regulation, there would thus be extensive testing of United States. new drugs before their introduction. Hence, it is incorrect to ascribe the generally safe and effective nature of modern drugs entirely THE IMPACT OF THE 1962 AMENDMENTS to FDA protection. The flip side, however, is that the drug devel- Before the 1962 amendments, the FDA was expected to approve a new opment process is inherently long, complicated, and costly. Even drug application within 180 days, unless the application failed to show without FDA oversight, some people would die waiting for new that the drug was safe. The 1962 amendments added a "proof of effi- drugs because self-interested manufacturers would insist on some cacy" requirement and also removed the time constraint on the FDA. The testing, and cautious physicians would proceed slowly in prescribe FDA has free rein to determine how much and what type of evidence it ing new drugs. will demand before approving a drug for sale, and thus may take as long The people who work at the FDA (and members of Congress) as it pleases before either granting or refusing approval. are publicly castigated when they "allow" a Type I error to occur- The 1962 amendments drastically increased the costs of introducing especially when it is a drug that kills people. Thus, FDA bureau- a new drug and markedly slowed the approval process. Before 1962, for crats have a strong incentive to avoid such errors. But when testing example, the average time between filing and approval of a new drug delays cause a Type II error, as with Septra, it is almost impossible application was seven months. By 1967, it was thirty months; and by the to point to specific people who died because the drug was delayed. late 1970s, it had risen to eight to ten years. The protracted approval pro- As a result, officials at the FDA are rarely attacked directly for such cess involves costly testing by the drug companies-more than $1 billion delays. Because the costs of Type II errors are much more difficult for each new drug-and delays the receipt of any potential revenue from to discern than the costs of Type I errors, there is an inherent bias at new drugs. Both the delays and the higher costs reduced the expected the FDA in favor of being "safe rather than sorry"-in other words, profitability of new drugs, so fewer new drugs have been brought onto excessive testing. the market. 6. Policies always have unintended consequences, and, as a result, Debate continues over how much FDA regulation is needed to their net benefits are almost always less than anticipated. In the ensure that drugs are both safe and efficacious, but there is little doubt case of government regulations, balancing incremental costs and that the 1962 amendments resulted in a U.S. "drug lag." On average. benefits (see principle 3) fails to make good headlines. Instead, drugs take far longer to reach the market in the United States than they what gets politicians reelected and regulators promoted are abso- do in Europe. Admittedly, it takes time to ensure that patients benefit lute notions such as safety (and motherhood and apple pie). Thus, from, rather than are harmed by, new drugs, but regulation-induced drug if a little safety is good, more must be better, so why not simply lag can itself be life-threatening. Dr. George Hitchings, a winner of the mandate that drug testing "guarantee" that everyone is free of risk Nobel Prize in Medicine, estimated that the five-year lag in introduc- from dangerous drugs? Eventually, the reality of principle 3 sinks ing Septra (an antibiotic) to the United States killed 80,000 people in in, but in this instance not before the drug lag had killed many this country. Similarly, the introduction of a class of drugs called beta people. blockers (used to treat heart attack victims and people with high blood6 CHAPTER ONE Death by Bureaucrat 7 LESSONS FROM THE FDA STORY 5. Things aren't always as they seem. Many analyses of the effects of What can we learn from the FDA regulation of new drugs that will guide government policies take an approach that does not fully recognize us in thinking about other public issues of our time? There are several the actions that people would otherwise have taken. Thus, official pronouncements about the effects of policies routinely misrepre key principles: sent their impact-not because there is necessarily any attempt to 1. There is no free lunch. Every choice, and thus every policy, entails deceive but because it is often difficult to know what would have a cost-something must be given up. In a world of scarcity, we can- happened otherwise. Pharmaceutical manufacturers, for example, not have more of everything; so to get more of some things, we must have strong incentives to avoid introducing drugs that are unsafe give up other things. Although FDA review of drugs saves lives by or ineffective because the companies are subject to loss of reputa- preventing the introduction of unsafe or ineffective drugs, the cost tion and to lawsuits. For similar reasons, physicians have strong is billions of dollars of added expenses, plus delayed availability of incentives to avoid prescribing such drugs for their patients. Even safe and efficacious drugs, resulting in the deaths of hundreds of without FDA regulation, there would thus be extensive testing of thousands of people new drugs before their introduction. Hence, it is incorrect to ascribe 2. The cost of an action is the alternative that is sacrificed. Econo- the generally safe and effective nature of modern drugs entirely mists often express costs (and benefits) in dollars because this is a to FDA protection. The flip side, however, is that the drug devel- simple means of accounting for and measuring them. That does not opment process is inherently long, complicated, and costly. Even without FDA oversight, some people would die waiting for new mean that costs have to be monetary, nor does it mean that econom- ics is incapable of analyzing costs and benefits that are quite human. drugs because self-interested manufacturers would insist on some The costs that led to the 1938 and 1962 amendments were the very testing, and cautious physicians would proceed slowly in prescribe visible deaths caused by sulfanilamide and the terrible birth defects ing new drugs. due to thalidomide. Subsequent revisions to the FDA process for The people who work at the FDA (and members of Congress) reviewing drugs, as with AZT and Taxol, have been in response to are publicly castigated when they "allow" a Type I error to occur- the deaths and other adverse health effects caused by the regulation- especially when it is a drug that kills people. Thus, FDA bureau- crats have a strong incentive to avoid such errors. But when testing induced drug lag. delays cause a Type II error, as with Septra, it is almost impossible 3. The relevant costs and benefits are the marginal (incremental) ones to point to specific people who died because the drug was delayed. The relevant question is not whether safety is good or bad; it is As a result, officials at the FDA are rarely attacked directly for such instead how much safety we want-which can only be answered delays. Because the costs of Type II errors are much more difficult by looking at the added (marginal) benefits of more safety com- to discern than the costs of Type I errors, there is an inherent bias at pared to the added (marginal) costs. One possible response to the the FDA in favor of being "safe rather than sorry"-in other words, sulfanilamide poisonings or thalidomide was to have outlawed new excessive testing drugs altogether. That would guarantee that no more people would be harmed by new drugs. But surely this "solution" would not be 6. Policies always have unintended consequences, and, as a result, sensible, because the marginal cost (more Type II errors) would ex- their net benefits are almost always less than anticipated. In the case of government regulations, balancing incremental costs and ceed the marginal benefit (fewer Type I errors) benefits (see principle 3) fails to make good headlines. Instead, 4. People respond to incentives. This is true whether we are talking what gets politicians reelected and regulators promoted are abso- about consumers, suppliers, or government bureaucrats. Here the lute notions such as safety (and motherhood and apple pie). Thus, incentive to amend the law in 1938 and 1962 was the very visible if a little safety is good, more must be better, so why not simply death and disfigurement of individuals. The eventual FDA decision mandate that drug testing "guarantee" that everyone is free of risk to speed up the review process was prompted by intense lobbying by from dangerous drugs? Eventually, the reality of principle 3 sinks individuals who believed (correctly, as it turned out) that they might in, but in this instance not before the drug lag had killed many benefit from drugs not yet approved. people.Flying the Friendly Skies? 17 CHAPTER 3 fifth may enable only an extra six to escape. (If this sounds implausible, imagine having a door for each person. The last door added will enable at most one more person to escape.) So we say that the marginal (or Flying the Friendly incremental) benefit of safety declines as the amount of safety increases. Let's look now at the other side of the equation. As the amount of Skies? safety increases, both the total and the marginal (incremental) costs of providing safety rise. Having a fuel gauge on the plane's instrument panel clearly enhances safety because it reduces the chance that the plane will run out of fuel while in flight.' It is always possible that a fuel gauge will malfunction, so having a backup fuel gauge also adds to safety. Because having two gauges is more costly than having just one, the total costs of safety rise as safety increases. It is also clear, however, that while the cost of the second gauge is (at least) as great as the cost of the first, the second gauge has a smaller positive impact on safety. Thus, the cost per unit of additional (incremental) safety is higher for Most of us hop into our car with little thought for our personal safety, the second fuel gauge than for the first. beyond perhaps the act of putting on seat belts. Yet even though travel on scheduled, commercial airlines is safer than driving to work or to the How SAFE IS SAFE ENOUGH? grocery store, many people approach air travel with a sense of forebod- ing, if not downright fear. How much safety should we have? For an economist, the answer to such If we were to think carefully about the wisdom of traveling six hun- a question is generally expressed in terms of marginal benefits and dred miles per hour in an aluminum tube seven miles above the earth, marginal costs. The economically efficient level of safety occurs when several questions might come to mind. How safe is this? How safe the marginal cost of increasing safety just equals the marginal benefit should it be? Because the people who operate airlines are not in it for of that increased safety. Put somewhat differently, if the marginal ben- fun, does their interest in making a buck ignore our interest in making it efits of adding (or keeping) a safety feature exceed the marginal costs home in one piece? Is some form of government regulation the only way of doing so, the feature is worthwhile. If the added benefits of a safety to ensure safety in the skies? device do not exceed the added costs, we should refrain from installing the device. Note there are two related issues here: How safe should we be, and how should we achieve that level of safety? THE ECONOMICS OF SAFETY Both of these issues took on added urgency on the morning of The science of economics begins with one simple principle: We live in a September 11, 2001, when terrorists hijacked and crashed four U.S. world of scarcity, which implies that to get more of any good, we must commercial jetliners. This episode revealed that air travel was far less sacrifice some of other goods. This is just as true of safety as it is of piz- safe than previously believed. Immediately, it was clear that we should zas or haircuts or works of art. Safety confers benefits (we live longer devote additional resources to airline safety. What was not clear was and more enjoyably), but achieving it also entails costs (we must give up how much additional resources should be thus devoted and precisely something to obtain that safety). what changes should be made. For example, almost everyone agreed As the degree of safety rises, the total benefits of safety rise, but the that more careful screening of passengers and baggage at airports would marginal (or incremental) benefits of additional safety decline. Consider a simple example: Adding exit doors to an airplane increases the number of people who can escape in the event of an emergency evacuation. Nev- 1 Notice that we say "reduces" rather than "eliminates." In 1978, a United Airlines pilot preoccupied with a malfunctioning landing gear evidently failed to pay sufficient attention ertheless, each additional door adds less in safety benefits than the previ- to his cockpit gauges. When the plane was forced to crash-land after running out of fuel, ous one. If the fourth door enables, say, an extra ten people to escape, the eight people died.B CHAPTER THREE Flying the Friendly Skies? 19 produce important safety benefits. But how should we achieve this? safety. Consumers would simply observe the safety offered by different Should carry-on bags be prohibited or just examined more carefully? airlines, the prices they charge, and then select the degrees of safety that How thoroughly should checked luggage be screened for bombs? Even best suited their preferences and budgets, just as with other goods. Infor- now, our answers to these questions are evolving as we learn more mation is not free, however. It is a scarce good, costly to obtain. As a about the extent of the threat and the costs of alternative responses to result, passengers may be unaware of the safety record of various airlines it. Nevertheless, throughout the process, economic principles can help or the competence of the pilots and the maintenance procedures of an us make the most sensible decisions. airline's mechanics. Indeed, even the airlines themselves may be uncer- In general, the efficient level of safety will not be perfect safety tain about the efficient level of safety, perhaps because they have no because perfection is simply too costly to achieve. For example, to be way of estimating the true threat of terrorist attacks, for example. Such absolutely certain that no one is ever killed or injured in an airplane possibilities have been used to argue that the federal government should crash, we would have to prevent all travel in airplanes-an unrealistic and mandate certain minimum levels of safety, as it does today through the impracticable prospect. This means that if we wish to enjoy the advan- operation of the Federal Aviation Administration (FAA). Let's look at tages of flying, we must be willing to accept some risk-a conclusion this issue in some detail. that each of us implicitly accepts every time we step aboard an airplane. One argument in favor of government safety standards rests on the assumption that when left to their own devices, airlines would provide THE IMPORTANCE OF CIRCUMSTANCES less safety than passengers want. This might happen, for example, if customers could not tell (at a reasonable cost) whether the equipment, Changes in circumstances can alter the efficient level of safety. For training, and procedures employed by an airline are safe. If passengers example, if a technological change reduces the costs of bomb-scanning cannot cheaply gauge the level of safety, they will not be willing to equipment, the marginal costs of preventing terrorist bomb attacks will reward airlines for being safe or punish them for being unsafe. If safety be lower. It will be efficient to have more airports install the machines is costly to provide and consumers are unwilling to pay for it because and to have extra machines at large airports to speed the screening pro- they cannot accurately measure it, airlines will provide too little of it. cess. Air travel will become safer because of the technological change. The conclusion is that government experts, such as the FAA, should set Similarly, if the marginal benefits of safety rise for some reason (perhaps safety standards for the industry. because the president of the United States is on board), it could be effi- cient to take more precautions, resulting in safer air travel. Given the fac- tors that determine the benefits and costs of safety, the result of a change Do CONSUMERS KNOW BEST? in circumstances will be some determinate level of safety that generally This argument seems plausible, but it ignores two key points. First, how will be associated with some risk of death or injury. is the government to know the efficient level of safety? Even if the FAA Airplanes are complex systems, and an amazing number of com- knows the costs of all possible safety measures, it still does not have ponents can fail. Over the century or so that humans have been flying, enough information to set efficient safety standards because it does not airplane manufacturers and airlines have studied every one of the mal- know the value that people place on safety. Without such information, functions thus far and have put into place design changes and operating the FAA has no way to assess the benefits of additional safety and hence procedures aimed at preventing recurring error. The efforts have paid no means of knowing whether those benefits are greater or less than the off. Between 1950 and 2010, for example, the fatal accident rate on U.S. commercial airlines was cut by almost 97 percent. added costs. Second, people want to reach their destinations safely. Even if they cannot observe whether an airline hires good pilots or bad pilots, they DOES THE GOVERNMENT KNOW BEST? can see whether that airline's planes land safely or crash. If it is safety that is important to consumers-and not the obscure, costly-to-measure Consumers have the greatest incentive to ensure that air travel is safe, reasons for that safety-the fact that consumers cannot easily measure and if information were free, we could assert with some confidence that metal fatigue in jet engines may be totally irrelevant to the process of the actual level of safety supplied by firms was the efficient level of achieving the efficient level of safety.20 CHAPTER THREE Interestingly, evidence shows that consumers are indeed cognizant of the safety performance of airlines and that they "punish" airlines that perform in an unsafe manner. Researchers have found that when an air- line is at fault in a fatal plane crash, consumers appear to downgrade their safety rating of the airline (i.e., they revise upward their estimates of the likelihood of future fatal crashes). As a result, the offending airline suffers substantial adverse financial consequences over and above the costs of losing the plane and being sued on behalf of the victims. These findings suggest a striking degree of safety awareness on the part of sup- posedly ignorant consumers. WHAT ABOUT TERRORISM? Of course, this discussion leaves open the issue of how to handle safety threats posed by terrorists and other miscreants. For example, much of the information that goes into assessing terrorist threats is classified as secret, and its revelation to airlines or consumers might compromise key sources of the data. Hence, there could be an advantage to having the government try to approximate the efficient safety outcome by mandat- ing certain screening provisions without revealing exactly why they are being chosen. Similarly, because airlines are connected in networks (so that people and baggage move from one airline to another in the course of a trip), achieving the efficient level of safety might require a common set of screening rules for all airlines. Even so, this does not inform us whether the government should impose those rules or the airlines should come to a voluntary joint agreement on them. We began this chapter with the commonplace observation that air- lines are safer than cars. Yet many people still worry for their safety every time they get on an airplane. Are they being irrational? Well, the answer, it seems, is in the eye of the beholder. Measured in fatalities per mile traveled, airplanes are about 15 times safer than cars (and 176 times safer than walking, we might add). This number masks the fact, however, that 68 percent of aircraft accidents happen on takeoff and landing, and these operations occupy only 6 percent of flight time. It is presumably this fact that quite sensibly makes people nervous whenever they find themselves approaching an airport. DISCUSSION QUESTIONS