Today in Iowa, Democratic presidential candidate Hillary Clinton unveiled a set of policies designed to tackle the high price of branded prescription medicines. Her plan, such as it is, wouldn’t solve the problem of high drug prices; in certain ways, it would make that problem worse. But advocates of the free market are mistaken if they think the pharmaceutical status quo is aligned with their principles. We don’t have a free market for innovative medicines—and it’s about time we enacted reforms that would achieve one.
Branded prescription drugs: a constitutionally sanctioned oligopoly
In a conventional market—say, the market for bananas—various farmers compete on price and quality to sell their bananas to consumers, or to intermediaries like grocery stores. Conventional laws of supply and demand dictate the price of a bunch of bananas.
Innovative medicines are usually accompanied by patents. For example, Gilead’s Sovaldi, a high-priced drug for hepatitis C, can’t be manufactured by anyone without Gilead’s permission, until its core patents expire sometime in the next decade (the precise date may be subject to litigation).
The only option for competitors is to come up with their own alternative treatments for the same disease. In the case of hepatitis C, AbbVie was able to develop a treatment called Viekira Pak, whose clinical data isn’t as strong as Sovaldi’s, but is good enough to provide some sort of price competition.
There are two problems with the hepatitis C example, that make it an imperfect one. The first is that it is extremely difficult to develop new drugs to treat a disease for which there is already an effective treatment, because it’s hard to design clinical trials that compare an effective drug with an experimental one. Abbvie lucked out because it completed most of its trials before Sovaldi was approved.
The second problem is that it’s prohibitively expensive to develop new drugs, thanks to the over-cautious regulatory process at the FDA.
Generic, off-patent drugs: a truly competitive market
Notice that I keep saying branded prescription drugs. When conventional, small-molecule drugs go off-patent, competition ensues in the form of generic medicines. That market is in fact a robust and inexpensive one.
Drug prices for conventional (non-protein) drugs drop by 80 percent, on average, when the drugs’ patents expire. And in the United States, thanks to a far-sighted 1984 law passed by Sen. Orrin Hatch (R., Utah) and former Rep. Henry Waxman (D., Calif.), nearly 90 percent of all prescriptions in the United States are for generic drugs administered in something approaching a free market. That’s far better than in Europe, where branded drugs continue to have substantial market share well after their patents expire.
The indirect way we pay for health care
The other big way that the government distorts the prescription drug market is in the way we pay for medicines: through the third-party purchase of third-party insurance. Not only are the vast majority of prescription drug costs paid for by a third party—either your health insurer or the government—but nearly 90 percent of us don’t buy insurance on our own; instead someone else buys it for us on our behalf.
This gives drug companies the strong economic incentive to charge whatever they want, knowing that patients with disease will rarely directly bear the cost; instead that cost is distributed widely to taxpayers and policyholders.
Hillary’s plan is a mish-mash of old policy mistakes
So here’s what Hillary is proposing today:
- Eliminate the ability of drug companies to treat direct-to-consumer advertising as a tax-deductible business expense, as other companies can.
- Shorten the patent life of innovative drugs.
- Prevent insurance companies from passing more than $250 of drug spending to consumers in the form of out-of-pocket costs.
- Allow the U.S. to import drugs from other countries where price controls are in place.
- Allow Medicare to negotiate prescription drug prices.
So, how does Hillary’s plan affect the underlying drivers of high drug prices that I’ve outlined above?
When it comes to FDA over-regulation, and the high barrier to entry for innovative new therapies, Hillary’s plan does absolutely zero. Indeed, by reducing the patent life of innovative drugs, her plan would make the risk-reward for new drug development even less favorable than it already is, entrenching incumbents. Strike one.
When it comes to the way our generic drug market works—and it’s already the most efficient such market in the world—Hillary proposes no major changes. At least she doesn’t make it worse. Ball one.
Allowing Medicare to negotiate prescription drug prices will accomplish very little, according to the Congressional Budget Office, in part because the Medicare prescription-drug benefit already has a robust system of private-sector drug price negotiation. Medicare Part D, as it’s officially called, has come in way under budget because that process has been so successful. Ball two.
Importing price-controlled drugs from other countries won’t achieve much either, because those other countries are much smaller than the U.S., and therefore can’t really affect the U.S. drug market. And drug companies have become increasingly sophisticated about managing their distribution channels, in order to prevent this kind of arbitrage in places like Europe, where it is legal. Ball three.
When it comes to the fact that we massively subsidize and distribute the financing of health care in America, in a way that makes drug companies less accountable for what they charge, Hillary’s plan goes backwards. It would force insurance companies to further subsidize those high costs. That will encourage more patients to use costly drugs, and only encourage drug companies to charge higher prices. And those higher prices will be passed onto Americans in the form of higher premiums and higher taxes. Strike two and three.
Hillary's prescription plan would cap out-of-pocket costs at $250 per month. What would you do with your savings? pic.twitter.com/bTIkVKAdkl
— Hillary Clinton (@HillaryClinton) September 22, 2015
A market-based solution to the problem of drug monopolies
If you want to bring the branded prescription drug market into the market-based world, you have to do two things.
First, you have to initiate a major effort to reform the FDA’s regulatory process, so that it no longer costs $2.6 billion, on average, to develop a new prescription drug. Congress’ 21st Century Cures initiative is a modest first step in the right direction, but we have much more to do. (Full credit, by the way, to Paul Howard and his colleagues at the Manhattan Institute’s Project FDA for pushing this initiative forward.)
Second, you have to level the playing field between prescription drug monopolies and the entities that pay for drugs: most importantly, private insurance companies. One way to do this might be to take a page from Switzerland, and allow private insurers in a given state to band together to jointly negotiate reimbursement rates for innovative drugs.
Right now, what happens is insurers roll over and pay for overpriced drugs, because they’re afraid that they’ll get hammered in the press–or lose market share to competitors—if they don’t. And at present, drug companies are legally prohibited from jointly negotiating drug prices, because the government would consider that to be collusion. If we loosened that restriction in the case of patented drug monopolies, drug companies would have more incentive to come to the negotiating table, and agree to a price that best represents the clinical and economic benefits of their innovative medicines.
The status quo is no good
One thing is clear: the status quo is no good. Whether you’re a socialist or a capitalist, it’s objectively true that some bad actors in the pharmaceutical and biotech world are exploiting distortions in the marketplace to charge prices for drugs that do not reflect what their value would be in a truly free market.
One thing you hear from defenders of the status quo is that drug companies need to charge high prices in order to continue to produce innovation. Well that’s not true in the rest of the economy. Google and Facebook charge nothing for the core products—search engines and social networks—and yet they are two of the most innovative companies in the world.
In the real economy, innovators know that they have to make products that are affordable to consumers, because otherwise no one will buy them. Thanks to decades of health policy mistakes, drug companies haven’t been held accountable in the same way. Let’s get them started.
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