Andrew Lo – MIT professor
If you are under 30, you probably use Facebook all the time. I’m not part of that demographic, so I don’t. But if I did, these are some of the photos that would be on my Facebook page: pictures of my friends, colleagues, and my mom. These people have one other thing in common besides me, they all died of cancer within the last few years. Cancer is personal for me, as I am sure it is for many of you.
So, by a show of hands, how many people here have dealt with cancer directly or have friends or family that are dealing with cancer? Yeah. Cancer touches all of us. So, I know that grieving is supposed to have five stages: denial, anger, bargaining, depression and acceptance. I probably won’t make it to acceptance, because I am still stuck on anger.
I’m sick and tired of losing friends and family to cancer, and I don’t accept it and neither should you. But what can I do? I’m just a financial economist. And cancer patients need a financial economist like a fish needs a 401(k) plan. But as I learned more about cancer and the business of cancer drug development, I now believe that financial engineering can play a major role in curing cancer.
Now before I tell you how I came to that strange conclusion, I need to make a disclaimer. You know, like the warning on drug commercials? I may cause disorientation, confusion or drowsiness, but they should all pass within 18 minutes. The real disclaimer is that I have no background in biomedicine. I’m not part of the biomedical industry, but like all of you who have friends or family with cancer, I want to help.
And four observations have convinced me that the financial industry and all of us can do a lot to bring cures to cancer patients faster.
The first observation is that drug development is getting harder and harder all the time, not easier. What’s the evidence? Here’s a graph titled “Eroom’s law” from an article on the efficiency of the pharmaceutical industry. The horizontal axis is time, and the vertical axis is this measure of efficiency, the number of new drugs approved by the FDA each year per billion dollars of R&D spending. And it’s been declining for decades. In case you are wondering, “Eroom’s law” stands for the opposite of “Moore’s law.” This is the exact opposite of what we’re experiencing in semiconductors, where we’re getting more and more efficient all the time.
Why is this happening? Especially when we’re getting smarter, year after year, thanks to all the breakthroughs made by scientists, clinicians and drug developers just in the last ten years. Well, it’s partly because we’re getting smarter that drug development is getting harder and financially riskier. I know that sounds counter-intuitive. Usually when we get smarter, things get easier and less risky, but it’s just the opposite in biomedicine.
As we learned more about the complexity of human biology and disease, we realized that there are many many things that can go wrong and a lot of possibilities for either fixing or preventing them from happening. And because of scientific and ethical reasons, we have to test each of those possibilities with a separate and independent clinical trial. And each clinical trial takes years and thousands of patients and hundreds of millions of dollars, which somebody has to pay for.
And that brings me to my second observation, which is that funding is declining because financial risk is increasing. So let’s talk about financial risk. It turns out, that most clinical trials are done by big drug companies. But ultimately, it’s the investors in those companies that have to pay for those trials, including you and me.
And here’s a fact about those costs. We like return, but we don’t like risk. And I’m going to give you an illustration of that. I’m going to show you an investment of a dollar in four different financial assets. I’m not going to tell you what they are, or even over what time span they last. I want you to take a look at these four assets, and tell me which one you would prefer if you could only have one. Try to balance the risk-reward trade-off for your own preferences.
Okay, by a show of hands, how many people want the green asset? Okay, how about the red asset? All right. How about the blue one? A few hands. And how about the yellow one? Yeah. Let the record show that most of you want the yellow asset.
Well, let me tell you what you all chose. First, the time span is from 1990 to 2008, and the first asset, the green one, is US Treasury bills, the safest asset in the world but not very attractive in terms of return. The second asset is the S&P 500, the US stock market: more return but more risk. The third asset, the blue asset, is Pfizer, the drug company, and it’s got an even better return but a lot more risk. Now what about the yellow asset? The one that most of you picked. The yellow asset is the feeder fund for the Bernie Madoff Ponzi scheme. And that’s why it ends in 2008. We all want more return and less risk; it’s human nature.
Now let me ask you about a second investment opportunity. This investment requires an upfront payment of 200 million dollars. It takes 10 years, where you get nothing in between, and in year 10, your payoff depends on drawing a ball from this urn. The urn has 20 balls, 19 of them are yellow, one of them red. And if you draw a yellow ball, you get nothing. But if you draw the red ball, you get 12.3 billion dollars! A fantastic payday, but remember, you only have a one out of 20 chance of picking that ball. 19 out of 20 times you get nothing.