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The issue of U.S. prescription drug prices

What’s at stake: Americans spend a lot on prescription drugs, more per capita than any other country by far. Individual cases of sharp price increases - like the case of the EpiPen - have recently driven attention to this issue. We report review contributions on this topic.

By: Date: August 24, 2017 Topic: Innovation & Competition Policy

The Hutchins Center and Center on Health Policy at Brookings has a good explainer of the facts. In 2015, the U.S. spent $325 billion on retail prescription drugs, equivalent to 1.8% of GDP, or 10% of total national health expenditures. Spending has grown considerably since the 1980s (Figure 1) and the U.S. spends substantially more per capita than other countries. According to the OECD, the U.S. spent $1,112 on retail pharmaceuticals per person in 2014, while the next highest spender was Canada, at $772, followed by Germany at $741 and France at $659 (Figure 2).

Figure 1

Figure 2

Timothy Taylor at Conversable Economist quotes a study by Dabora, Turaga, and Schulman in the Journal of the American Medical Association, who provide a useful diagram summarizing the US prescription drug market (Figure 3). They notice that there is a fairly high amount of concentration at a number of places in this market schematic. The US distributor market is highly consolidated, with 3 companies accounting for more than 85% of market share: AmerisourceBergen, Cardinal Health, and McKesson. The retail pharmacy market can be divided into 3 major categories: chain pharmacies and mass merchants with pharmacies, independent pharmacies, and mail-order pharmacies. The 15 largest firms, including CVS, Walgreens, Express Scripts, and Walmart, generated more than $270 billion in revenue in 2015 through retail and mail-order pharmacy, representing approximately 74% of retail prescription revenues.

Figure 3

In another paper published by the Journal of the American Medical Association, Kesselheim, Avorn, and Sarpatwari show that list prices for the top 20 highest-revenue-grossing drugs are much higher in the US than the United Kingdom, and even post-rebate prices are higher in the US than in Canada, France, and Germany (Table 1). They argue that the higher per capita prescription drug spending in the US is largely driven by brand-name drug prices that have been increasing in recent years at rates far beyond the consumer price index. They argue that the most important factor allowing manufacturers to set high drug prices is market exclusivity, protected by monopoly rights awarded upon Food and Drug Administration approval and by patents. The availability of generic drugs after this exclusivity period is the main means of reducing prices in the US, but access to them may be delayed by numerous business and legal strategies. Although prices are often justified by the high cost of drug development, Kesselheim et al. argue that there is no evidence of an association between R&D costs and prices and rather prescription drugs are priced primarily on the basis of what the market will bear.

At the heart of the pricing question there is tension between two competing aims: on one hand, giving pharmaceutical companies financial incentives to innovate and produce new drugs; on the other, keeping drug prices as low as possible. Timothy Taylor points out five takeaways from the literature on high prices. First, Prices are rising for brand-name drugs, and competition between brand-name drugs doesn’t seem to bring down prices. Second, while competition from generic drugs often does help to bring down prices, that competition faces a number of limits, particularly when a generic for a relatively rare condition has a monopoly. Third, the big government purchasers of drugs, Medicare and Medicaid face legislative limits in encouraging or requiring the purchase of cheaper drugs or generic drugs. Fourth, prescription benefit managers are typically paid according to the total revenues of the drugs they manage, and thus lack a strong incentive to negotiate for lower prices. Fifth, state-level laws also tend to protect brand-name drugs by hindering competition from generics and lastly, large self-insured employers have traditionally felt that the potential cost savings from negotiating hard over drug prices, or pushing for alternative and cheaper drugs, wasn’t worth the risk of a bad public relations episode.

Gilbert Berdine at the Mises Institute argues that the “outrageous” drug prices that are often in the news should not be seen as an example of failure by free-market capitalism, but rather as an example of how anticompetitive government regulations break functioning markets in favor of rent seeking corporations. Monopoly privilege enables pricing that extracts the last bit of disposable income from customers, but monopoly cannot, by itself, extract more from a customer than the customer can pay. The final policy element necessary for the outrageous prices is public financing, intended as the the fact that the cost of the drug is paid the public. With public financing, pharmaceutical companies stop making pricing decisions based on the economics of affordability and pursue rent seeking behaviors, and rent seekers try to acquire political privilege rather than compete by innovation.

Doug Bandow at the Cato Institute laments that the comparison to other countries is misleading because those countries benefit from spillovers from American research. He argues that if Congress imposed similar controls in America, many promising new drugs simply wouldn’t be developed because there is no foreign market upon which the U.S. could free ride. The congressional debate so far has focused on adding a drug benefit to Medicare to assist the elderly. But both houses of Congress have also passed bills, set to go to a joint conference committee, to allow importation of U.S. drugs from other countries. This “reimportation” strategy is superficially appealing, Bandow argues, but what its supporters really desire is price controls and their legislation would effectively subject U.S. firms to foreign restrictions.

Patent monopolies have long been used as a mechanism for financing innovation and research, but they can also provide incentives for a wide-range of rent-seeking behaviors. A 2015 report by the Centre for Economic Policy Research assessed the cost associated with one form of rent-seeking, the mismarketing of drugs. This can occur when a drug company seeks narrow Food and Drug Administration (FDA) approval of a drug then promotes its use for other purposes. In addition, companies may conceal evidence that their drugs are less effective than claimed or possibly even harmful. The authors of the report find that in the case of just five drugs, this form of rent-seeking has resulted in cumulative costs of morbidity and mortality of $382 billion.


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