Pharmaceutical innovation accounts for over one-third of recent life expectancy gains. This innovation is primarily incentivized by patents and FDA-awarded market exclusivities, but the effects of market exclusivity periods on different stages of the drug development pipeline are not well understood. In this paper, we estimate the causal effects of extending market exclusivity for antibiotics, a critical drug class where social value may exceed private returns. Using a difference-in-differences approach, we show that the Generating Antibiotic Incentives Now (GAIN) Act – which granted five additional years of exclusivity for antibiotics but not antivirals or vaccines – increased innovative activity across multiple stages of antibiotic development. Comparing antibiotics to a control group of antivirals and vaccines, we find positive effects on patenting, preclinical studies, and phase 3 clinical trials. We also find larger effects among drugs with more novel patents, and the majority of post-GAIN antibiotics contained novel active ingredients. These findings underscore the importance of financial incentives, such as market exclusivity extensions, in fostering high-quality innovation for socially valuable but commercially challenging drug categories.

Adverse selection is a classic market failure known to limit or “unravel”' trade in high-quality insurance and many other economic settings. While the standard theory emphasizes quality distortions, we argue that selection has another big-picture implication: it unravels competition among differentiated firms, leading to fewer surviving competitors—and in the extreme, what we call “un-natural” monopoly. Adverse selection pushes firms toward aggressive price cutting to attract price-sensitive, low-risk consumers. This creates a wedge between average and marginal costs that (like fixed costs in standard models) limits how may firms can profitably survive. We demonstrate this insight in a simple model of insurer entry and price competition, estimated using administrative data from Massachusetts' health insurance exchange. We find a large “selection wedge” of 20-30% of average costs, which (without corrective policies) unravels the market to monopoly. Our analysis suggests a surprising policy implication: interventions that limit price-cutting can improve welfare by supporting more entry, and ultimately lower prices.