The underlying issue is one of intellectual property, which, in relevant part, operates in the pharmaceutical industry just as it operates in the arts. Article I, Section 8, Clause 8 of the U.S. Constitution grants Congress the power "To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries." The resulting patent rights and copyrights exist not primarily to make money for inventors and artists but to provide them with a financial incentive to come up with their works in the first place, explicitly for the benefit of society generally. In the case of patents, inventors get an exclusive right to the financial rewards of their patented subject for a limited time (20 years in the case of pharmaceuticals) as a trade-off for publishing the technology embodied in their inventions.
Invention is, however, a hit-or-miss prospect. Doug Bandow writes in Policy Analysis, "Of every 5,000 to 10,000 substances reviewed [by pharmaceutical companies' research & development organizations], only about 250 make it to the animal-testing stage. Around 5 of them go on to human clinical trials. Only one, on average, makes it into the market. Even at that point, only 3 of 10 new drugs actually make money." This academic study from the Journal of Health Economics 22 (2003) estimates the cost of developing a new drug as $802 million (in year 2000 dollars; $403 million is out-of-pocket expenditures, the remainder opportunity costs).
Understanding what reimbursement includes requires a basic grasp of business organizations. People tend to speak of "corporations" anthropomorphically, as if they acted for their own interest. The directors and management make the decisions but within limits set by the corporation's by-laws as well as federal and state statutes, regulations, and, perhaps most importantly, fiduciary duties that require them to act in the interest of the shareholders, who are, of course, the owners of the corporation. Pharmaceutical companies thus have to compete in the capital markets for investors' money; if the profits they return on those investments are not competitive, investors will take their money out of the pharmaceutical companies. If the company's revenue and profits decline, past a certain point it will make better sense to liquidate the company than to continue operating it.
The way the directors and management of drug companies make money for the shareholders is by developing and commercially exploiting drug compounds and processes, and the period of patent protection is essential to their success. Profits in the pharmaceutical industry are high (Ronald Bailey puts them at 9% as against 5% typical of many other American industries), but higher-risk investments always earn supernormal returns or the money would flow to less risky ventures. And drug companies do face greater risk: if you open a shoemaking business you can be fairly certain that your factory will produce shoes; if you launch a pharmaceutical R&D organization, however, you have no assurance at all that it will produce a marketable compound, and even if it does the risk of class-action tort suits seeking damages for deleterious side effects never goes away.
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