Product recalls, market size and innovation in the pharmaceutical industry

Abstract: The idea that research investments respond to market rewards is well established in the literature on markets for innovation (Schmookler, 1966; Acemoglu and Linn, 2004; Bryan and Williams, 2021). Empirical evidence tells us that a change in market size, such as the one measured by demographical shifts, is associated with an increase in the number of new drugs available (Acemoglu and Linn, 2004; Dubois et al., 2015). However, the debate about potential reverse causality is still open (Cerda et al., 2007). In this paper we analyze market size's effect on innovation as measured by active clinical trials. The idea is to exploit product recalls an innovative instrument tested to be sharp, strong, and unexpected. The work analyses the relationship between US market size and innovation at ATC-3 level through an original dataset and the two-step IV methodology proposed by Wooldridge et al. (2019). The results reveal a robust and significantly positive response of number of active trials to market size.