What Do Macroeconomic Trends Tell Us About the Biomedical Outlook?

Notwithstanding the geopolitical volatility that hit markets at the start of 2020, the widespread belief among macro-economists is that generally ambient conditions that prevailed in 2019 have continued into the new year and will stay for the near-term. At the same time, there are concerns that some underlying macro-economic imbalances and could have deeper ramifications and / or cause sudden shocks.  Also, the impending 2020 presidential election imparts unpredictability into the environment. 

The outlook for the biomedical sector reflects these macro-economic trends. On the one hand, the biomedical sector will remain supported in the near-term by favorable fiscal and monetary policies. On the other hand, longer-term macroeconomic, demographic and social imbalances could upend and disrupt the sector. Finally, an element of uncertainty hangs over the sector as the 2020 election unfolds.

Ambient Near-Term Macroeconomic Conditions

In the years since after the financial crisis, US GDP growth has remained in a 1.5-3.0% range. Growth touched nearly 3% in 2018 but slowed in 2019. It is expected to come off further in 2020, printing in or around 2%.  While lower, this growth rate must be viewed in the context of a 10-year old economic expansion – the longest ever recorded. Moreover, the IMF’s forecasts imply continuing growth until 2024 with only gradual deceleration.

Inflation continues to be subdued, as it has been since ever after the financial crisis. Despite the lowest unemployment rate since the Korean war, wage pressures have stayed in check. As per the IMF, core personal consumption expenditure inflation will likely hover just below or above 2% all the way until 2024.

Fiscal policy has been very stimulative. A recent analysis of fiscal policy in the Financial Times showed that for the past two fiscal years, and for the next two, Congress has agreed to a spending stimulus for President Trump’s economy 3-5 times greater than that what it gave under President Obama.  Although the fiscal stimulus will fade, Goldman Sachs’ research suggest this will likely be more than offset by the waning of the drag from trade war with China.   

With regard to monetary policy, concerned about adverse fallout from the trade war with China, the Federal Reserve changed course from raising interest rates and instead pivoted to two rate cuts in 2019. While the Fed is staying away from further cuts for the moment, it has promised to also not raise interest rates. It will make changes in either direction only if it sees material changes to its outlook, thereby leaving a pretty stimulative monetary policy in place.

In summary, while GDP growth is expected to be moderate and inflation remains subdued, both fiscal and monetary policy have been relatively aggressive. Indeed, monetary policy will remain so for the foreseeable near-term. 

Longer Term Imbalances

While the near-term conditions appear ambient, beneath the surface the US economy is faced with several imbalances. 

To start with, overly loose fiscal and monetary policies have created problems in their wake. The IMF reports that President Trump’s fiscal stimulus appears to have been unsuccessful in stimulating investment, especially for companies that already enjoy rich margins. Yet, the cost of fiscal stimulus (corporate tax cuts) has risen from the initially projected $1.5 trillion to $1.9 trillion, around 10% of current GDP. The consequent rise in fiscal deficit is pushing public debt towards an unsustainably high level in the medium term and meanwhile also immediately putting upward pressure on the US external deficit.

Easier monetary policy is also building increased macro-financial risk as companies have become increasingly indebted and even lower-rated companies have had easy access to financing. With plenty of liquidity available, prices of financial assets too have been pushed up. All of these factors together make the economic system vulnerable to sudden or unanticipated changes.

Of course, loose fiscal and monetary policies have in any case not been too successful in aggregate - evidenced by the fact that GDP growth remains confined to a relatively narrow range. One explanation for this may come from the increased concentration of corporate market power across industries. With superstar companies in concentrated industries already enjoying high margins, their investments tend to remain unresponsive to external stimuli.  

In parallel to concentration of corporate market power, another imbalance that has become increasingly relevant to macroeconomic discussions is concentration of income and wealth, accompanied by eroding economic mobility and adverse social outcomes. Among other effects, income and wealth concentration suppresses aggregate demand (the less well-off spend less) and puts pressure on fiscal costs (the less well-off need greater assistance). 

In short, a number of longer-term complex and interacting imbalances have been building up below the surface.  

From the Aggregate Economy to the Healthcare Sector

The healthcare sector has a complex relationship with the aggregate economy. Some of the best economists have been analyzing the relationship, so we have at least a tentative understanding of how it works.

One intuitive question is whether economic conditions directly impact disease incidence, morbidity or mortality. The evidence is as yet inconclusive. Most likely, there is a complex set of social and economic factors operating over generations that cannot be reduced to a direct causal relationship.

While health conditions seem difficult to pin down to the economy, there is a more tangible relationship between the economy and healthcare expenditures. In gist, healthcare expenditures rise because of two complementary reasons (a) as aggregate income rises, consumption grows slower than income and people instead prefer to shift spending towards health (b) as newer medical technologies develop, they trigger a rise in health expenditures.  Although economists disagree about the relative strength of these two factors, there is general consensus that together they imply that the healthcare sector will rise grow faster and account for a rising share of the overall economy – some suggest that it will approach 30% of GDP over the coming decade.  

The theoretical predictions of economists directionally show the same trends as those of analysts and actuaries from CMS, albeit the latter projects that health expenditures will represent “only” 19.4% of GDP in 2027. CMS sees that national health spending growth during 2018–27 will be a resumption of long-observed demographic and fundamental health factors, after a ten-year period largely in??uenced by the Great Recession and major health reform. Over this period, CMS believes that net gains in health insurance coverage will keep pace with population growth, keeping the insured share of population stable at 90%.

In its projections, CMS also breaks out who will drive the healthcare spending and on what items. Among the major insurers or healthcare payers, average annual spending growth in Medicare (7.4 percent) is expected to exceed that in Medicaid (5.5 percent) and private health insurance (4.8 percent) over the projection period, mostly as a result of comparatively higher projected enrollment growth. Prices for health care goods and services are projected to grow 2.5 percent per year, on average, for 2018-27 - faster than the average price growth experienced over the previous decade -and to account for nearly half of projected personal health care spending growth.

The Upshot for the Biomedical Sector

The outlook for the biomedical sub-sector reflects these macro-economic trends and the effects they have on the broader healthcare sector. On the one hand, the biomedical sector will remain supported in the near-term by favorable fiscal and monetary policies. On the other hand, longer-term macroeconomic, demographic and social imbalances could upend and disrupt the biomedical sector. 

First and foremost, slowing of near-term GDP growth will have limited impact on the biomedical sector. Indeed, since the slowdown is being addressed by still relatively aggressive fiscal and monetary policies, the biomedical sector may in fact benefit. On the fiscal front, while corporate tax cuts may not have so far been very successful in directly driving corporate investment, in many cases they have placed cash in the hands of investors through buybacks, dividends etc. Depending on whether investors forecast opportunities for the attractive returns they experienced over the last decade, their newly gained cash is in principle available for investing in public or private biotech companies. And given the Federal Reserve’s promise to keep rates on hold at very low levels, such liquidity generally creates a “risk-on” financial environment that drives up tech and biotech stocks. 

Putting the effects of fiscal and monetary policies together, it appears that near-term capital flow to the biomedical sector will largely remain favorable, supporting the kind of innovative R&D breakthroughs that have become common in recent years. One can expect that this easy capital situation will also continue to underpin M&A activity in the sector in the immediate future, providing attractive payouts to the founders of innovative biomedical companies that get acquired. 

While the near-term picture looks positive, it is difficult to be as sanguine for the medium-term.   To start with, concerns over the fiscal deficit will sooner or later spill over to concerns over healthcare spending. While it is corporate tax cuts that may have exposed the fault line, attention will sooner or later turn to the growth in government spending on Medicare – projected to grow 7% a year as per CMS and by the Congressional Budget Office to increase from 3.5% of GDP to over 5% of GDP within a decade. It is not difficult to see the kind of blowback such projections of explosive spending growth will engender; even the conservative IMF recommends containing healthcare cost inflation.  As we have seen in the run-up to the 2020 (and every) election, these kinds of pressures invariably rebound on drug prices.  

Next, the massive surge in financial asset prices and leverage across the system leaves macro-financial risks scattered across the system. The biomedical sector is heavily dependent on high-risk equity funding and on the IPO window. Unsurprisingly, therefore, the sector has a history of being among the most vulnerable to financial shocks or contagion from other sectors.     

Outrage over drug prices and macro-financial vulnerabilities have hounded the biomedical industry from its earliest days. What is a newer and somewhat surprising threat, though, is concern over antitrust issues, probably spilling over from fears of the kind of concentrated market power being exercised elsewhere by Big Tech companies.   One-off mega-mergers of big pharmaceutical giants aside, much of biomedical M&A and business development activity is motivated by the urge to acquire or sharpen focus on innovative assets. In general, this has the beneficial effect of spurring fresh rounds of innovation and entrepreneurship rather than concentrating corporate power. However, as recent examples of Roche-Spark Therapeutics and Illumina-Pacific Biosciences show, antitrust authorities have started taking deeper interest in biomedical deals – and slowing if not stymieing a few.               

Another kind of economic concentration, though, has more obvious repercussions for the biomedical sector. As incomes and wealth become more unequal, voices on the progressive left as well as the populist right become more pressing and powerful. This typically strengthens calls for radical overhauls of the healthcare system including highly interventionist, European-style policies for procurement and pricing of biomedical products.  Whether or not such radical overhauls ever see light of day, the political chatter definitely creates an overhang over the biomedical sector and biomedical investors. The 2020 elections impart a spike in unpredictability – witness proposals such as “Medicare For All” - but, regardless of the election outcome, the overhang is likely to persist over the coming years.     

Summary

Slowing GDP growth is expected to leave favorable fiscal and monetary policies in place for the moment. This will allow capital to continue to flow to the biomedical sector in the near-term and will also support M&A activity.   

However, the medium-term is more challenging. As healthcare spending consumes an ever-larger share of GDP and the government budget, experts will press for containing healthcare price inflation. Meanwhile, any sparking of macro-financial risks built over a long period of expansionary monetary policy can be disruptive to biomedical funding and IPOs. 

Other macroeconomic imbalances are having their ramifications too. The concentrated market power amassed by Big Tech companies has fueled antitrust fervor that is sweeping biomedical M&A in its wake. Income and wealth inequalities are making interventionist policies more acceptable which will inevitably rebound on a sector as prominent as healthcare. 

Finally, the unpredictability surrounding the 2020 elections could be a foretaste of an overhang over the biomedical sector in the coming years.     

References

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Chandra, Holmes and Skinner (2013) “Is This Time Different? The Slowdown in Healthcare Spending”, NBER Working Paper 19700, December

CNBC (2020) “JP Morgan Tells Clients A Progressive Overhaul of Economy is One of 2020’s Biggest Risks”, Jan 7

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Sisko, Keehan, Poisal, Cuckler, Smith, Madison, Rennie and Hardesty (2019) “National Health Expenditure Projections 2018-2027: Economic and Demographic Trends Drive Spending and Enrollment Growth”, Health Affairs Vol 38 No. 3, February