Technical Change and Firm Size: The Pharmaceutical Industry

FISHER and TEMIN (1973) have argued recently that many empirical studies1 relating to the Schumpeterian hypothesis are inappropriate for testing that hypothesis. They observe that Schumpeter can be interpreted as hypothesizing that the elasticity of the value of research and development (R and D) output with respect to firm size is greater than unity. On the other hand, the empirical studies have been concerned with investigating the elasticity of R and D inputs with respect to firm size. Fisher and Temin demonstrate that a finding that the R and D input elasticity exceeds unity does not imply that the R and D output elasticity exceeds unity also. Given that public policy formulation should be based on tests of the Schumpeter hypothesis rather than on tests of the R and D input elasticity, their point is well taken. Of course, in defense of the empirical studies, it can be argued that data limitations have restricted testing to the R and D input elasticity, and that most of the researchers have been aware that they were not testing the Schumpeter hypothesis. In a footnote, Fisher and Temin refer to a study of technical change in the pharmaceutical industry that does attempt to test the Schumpeter hypothesis directly.2 This study by Comanor (1965) examines the relationships among firm size, R and D inputs, and technical change in the United States pharmaceutical industry for the period 1955-1960. The amount of technical change accomplished by a firm is measured by its sales during the first two years following introduction of all new chemical entities. An important conclusion of the study was that ". . . there are substantial diseconomies of scale in R and D which are associated with large firm size." (Comanor, 1965, p. 190). Because the pharmaceutical industry is one of the rare industries for which adequate data are available to test the Schumpeter hypothesis directly, we have attempted to test the hypothesis in that industry for the more recent period, 1965-1970. Another reason for our work was to try to overcome some difficulties in Comanor's analysis that raise ambiguities of interpretation. As we shall report, our work leads to results that are essentially opposite those of Comanor. Our finding for the 1965-1970 period, that larger firms were "better" at innovation than smaller firms, has another interesting implication. That is, accepting Comanor's findings of the opposite case for the 1955-1960 period, one might be led to hypothesize that the 1962 Amendments to the Food, Drug and Cosmetic Act inadvertently provided an advantage to larger firms. The 1962 Amendments added a "proof-of-efficacy" requirement to the "proofof-safety" requirement of the 1938 Food, Drug and Cosmetic Act. In effect, the 1962 Amendments increased the costs associated with introducing new drugs by requiring extensive tests and evaluations not required previously. In order to investigate further the effect of the 1962 Amendments, we applied our model to 1955-1960 data. We found that larger firms were "better" at developing new chemical entities in that period also, but their relative advantage over smaller firms was smaller than in the post-1962 period (see footnote 18). The plan of this paper is as follows: First, we summarize and point out several problems we found with Comanor's study. Section III presents the results from a two-equation model that decomposes the technical change measure Received for publication July 5, 1973. Revision accepted for publication January 16, 1974. The authors are grateful to M. A. Adelman, M. Bronfenbrenner, D. Davies, F. Fisher, W. Gruber, T. Seaks and D. Schwartzman, and an anonymous referee for helpful comments. We are especially indebted to H. Grabowski for his very thorough criticisms of the first draft. All errors and judgments are the authors' responsibility. 1 Fisher and Temin refer to the studies by Villard (1958), Schmookler (1959), Worley (1961), Mansfield (1964), Scherer (1965), and Comanor (1967). 2 In addition to the 1965 Comanor study, Mansfield (1964) and Scherer (1965) also have made studies that fall into this category. 'For a summary of both studies, see Vernon (1972).