Procurement Regimes and Medical Innovation

Why has medical innovation brought cost-increasing enhancements to quality, rather than cost-reducing advances in productivity? The column uses a new dataset drawn from patents for prosthetic devices to show that the design of incentives for innovators can have substantial effects on these margins. Fixed-price procurement arrangements induce greater effort to reduce production costs than cost-plus procurement arrangements. Procurement models may therefore inadvertently lead to 'missing innovations'.

Healthcare spending has risen substantially since 1960. In the US, spending has risen from 5% to nearly 18% of GDP, while across the UK, France, Germany, and Japan, it has risen, on average, from just under 4% to just under 11% of GDP. Research has long connected this growth in cost to medical innovation (Smith et al. 2009, Cutler 2004).