Ten Myths about the Market for Prescription Drugs

Policy Reports | Health

No. 230
Friday, October 01, 1999
by Robert Goldberg

Executive Summary

Critics complain that prescription drugs have contributed to a massive increase in health care spending in the United States. Some critics contend that drug prices are too high and propose lowering them through price controls. For example, the Prescription Drug Fairness for Seniors Act, currently before Congress, imposes a form of price controls on drugs sold to the elderly. Many complaints about price, and the laws those complaints spawn, are based on a misunderstanding of how the prescription drug market works. Following are some of the most common myths.

Myth No. 1: American Spend Too Much on Prescription Drugs. Per dollar spent, drugs offer a better return on health care spending than virtually any other health care option. Using prescription drugs often reduces or eliminates the need for costlier health care services. One recent study found that every dollar spent on drugs is associated with a $4 decline in spending on hospitals. The decline in total spending due to greater use of prescription drugs is particularly notable in the treatment of cancer, heart disease, Alzheimer's, AIDS and mental illness.

Myth No. 2: Drug Costs Are Rising Because of Price Increases. Drug cost increases are due primarily to nonprice factors, including increased volumes of prescriptions, record sales of new products and a changing mix of available products. Price increases to date have been relatively modest. According to a survey by IMS Health:

  • Of a 14.2 percent increase in total drug costs in 1997, only 2.5 percent stemmed from price increases.
  • Of a 15.7 percent increase in total drug costs in 1998, only 3.2 percent was caused by price increases.

Myth No. 3: Americans Spend Too Much on Highly Advertised Brand-Name Drugs Instead of Purchasing Less-Expensive, Generic Drugs. Although generic drugs are supposed to be clinically identical to the brand-name drugs they replace, doctors and patients find that some effects are not uniform. Still, the market share of generic drugs more than doubled in a dozen years - from 18.6 percent in 1984 to 41.6 percent by 1996. According to some predictions, in the year 2000 about 70 percent of U.S. prescriptions will be filled by generic drugs.

Myth No. 4: Drug Prices Are Higher in the United States than in Other Developed Countries. Drug prices in the United States are not very different from prices in other developed countries.

  • Using accurate pricing information, health economist Patricia Danzon has found that drug prices in Canada, Germany, Switzerland and Sweden are higher on average than prices in the United States.
  • When "purchasing power parity," a means by which economists attempt to compare the price of goods in different countries, is considered, the Organization for Economic Cooperation and Development has found that Americans spend less per capita per year on drugs than do people in Germany or France and only slightly more than those in Canada and Italy - yet the other countries have controls.

Myth No. 5: Americans Could Reduce Their Drug Costs If They Paid the Same Prices as People in Less-Developed Countries. Critics of the U.S. system complain that consumers can buy drugs in Mexico for less than half their cost in the United States. Prices for the same drugs do differ in different countries, but Americans cannot get the newest drugs at Mexican prices for a simple reason. The research and development required to ready a drug for production can cost millions of dollars and take many years, but the cost of actually manufacturing a drug is usually small. Because manufacturers have discretion about pricing, the price may be close to production costs in poorer countries, which could not otherwise afford the drug, and higher in wealthier countries - more accurately reflecting the drug's value to patients. If all patients paid the lower price, there would be no money for research and development and no new drugs.

Myth No. 6: Seniors Are Overcharged for Drugs. Critics have produced a study that attempts to show that seniors pay twice as much for drugs as anyone else, but the study used inaccurate pricing information. Sixty-five percent of Medicare beneficiaries have some form of prescription drug benefit plan to help with their costs. In addition, seniors can buy drugs at a discount through AARP, private buying clubs, other organizations and discount pharmacies. A new study by Milliman & Robertson, the nation's leading actuarial consulting firm on health benefits, concludes that senior citizens could have comprehensive coverage for prescription drugs in addition to other Medicare benefits with virtually no increase in personal costs if private health plans were allowed to administer the benefits.

Myth No. 7: Price Controls Can Reduce Drug Spending. Attempts to drive down drug costs through price controls have two unintended results: (1) they encourage increased consumption of drugs and (2) they lead to the consumption of inferior drugs. Many European health systems with price controls spend more on drugs per capita than the United States spends, but Americans use newer and more appropriate medications. That is one reason Americans spend less time in hospitals when they are sick and have a higher quality of life than do Europeans.

Myth No. 8: Price Controls Would Reduce Drug Costs for Seniors. The Drug Fairness for Seniors Act would require drug manufacturers to offer all seniors the discounts now offered only to a very few government agencies, primarily the Veterans Administration. Yet, if the act became law, seniors would likely pay more, not less, for their prescriptions. At the earliest opportunity, drug manufacturers would steeply increase prices charged the VA. Further, to get the discount, pharmacies would have to do an estimated $15 worth of paperwork to prove to the manufacturer that each Medicare beneficiary was eligible - a cost pharmacies would pass on if possible. Thus seniors would end up with higher prescription drug bills.

Myth No. 9: We Can Have Price Controls without Rationing Drugs. If federal price controls for pharmaceuticals were adopted, an increase in consumption of pharmaceuticals would be inevitable and the government would then try to control the increase. That is what happened with erythropoietin (EPO), which is used to reduce anemia in kidney dialysis patients. Medicare, which pays for drugs for kidney dialysis, put a price control on EPO in 1994, rationed the amount patients could get and refused to cover patients with healthy blood cells above a certain level.

Myth No. 10: Price Controls Don't Affect Research and Development. Enactment of price controls or cost containment programs or both leads to decreased research and development spending simply because there is less money to be reinvested in R&D. Several countries that have implemented such programs have seen their pharmaceutical industries decline or go abroad. The United States, with no widespread price controls on drugs, produces by far the most innovative drugs.

Price controls represent not a mere extension of market pressure but a fundamental shift in values. Controls substitute a political process for the marketplace. For controls to work, individuals must be forced to adhere to governmental and bureaucratic decisions. This allows a few "experts" to decide what pharmaceuticals millions of physicians, pharmacists, medical researchers and patients "deserve" - and at what prices.

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