Ten Myths about the Market for Prescription Drugs
Myth No. 10: Price Controls Don't Affect Research and Development
"The U.S. with no widespread price controls, develops a high percentage of the world's innovative drugs."
Rep. Henry Waxman (D-Calif.) is a prominent critic who claims that government efforts to control drug prices have no effect on research and development. However, experience with price controls belies his assertion. Enactment of price controls or cost containment programs or both decreases research and development spending 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. As Figure IV indicates, the United States, with no widespread price controls on drugs, develops a high percentage of the world's most innovative drugs.
- The United States developed 45 percent of all drugs marketed worldwide in the 1990s.
- The United Kingdom developed 14 percent of all global drugs and no other country developed more than 9 percent.
Why Price Controls Hurt Innovation. Whereas U.S. companies often have their eye on the worldwide market when they start to develop a new drug, European and Japanese companies produce largely local products. Their minor innovations are "either directly imitative of existing products or [are] unsafe products that cannot clear regulatory hurdles in many nations, or are products that fill minor local niches."33 Indeed, "of the top 50 products (by value) in each of four European countries in 1993, 10 of those in Italy and France were classed as useless, compared with six in Germany and none in the U.K."34 In France, lax standards to ensure a new drug's effectiveness also have contributed to the development of drugs that were safe but of dubious therapeutic value; such drugs accounted for up to 20 percent of total sales.35
What has happened in one of the largest prescription markets - cardiovascular products - illustrates that countries with price regulation tend to be less innovative.36
- In the 1980s nine different beta blockers were developed in the United States and the United Kingdom, 14 in France and 30 in Japan.
- Today low prices in Japan and France have discouraged firms in those nations from discovering major new products, and the United States has become the world's leader in developing new cardiovascular therapies, having surpassed the U.K. in the early 1980s.
Another way to assess the influence of price controls on innovation and global competitiveness is to examine recent measures in countries that have had price controls over the years. As the following overview suggests, different types of price and product regulations appear to reduce investment in innovative medicines.
"Ten of the top 50 drug products in Italy and France were classed as useless."
Case Study: United Kingdom. The Pharmaceutical Price Regulation Scheme (PPRS), in force since 1977, regulates profits and return on capital and explicitly encourages innovative research with higher profit margins and higher introductory prices. As a result, United Kingdom drug prices have been higher than the European average. Rates of return are negotiated and regulation extends only to home market sales. In fact, higher rates of return are provided for "export-oriented" firms. As a result, Britain's pharmaceutical industry was highly innovative and profitable during the 1970s and 1980s.
However, as cost containment became paramount, the policy of promoting innovation through higher prices and profits was dramatically altered. First, the National Health Service (NHS) tried to keep costs in check by limiting how much doctors could prescribe. More directly, the British government reduced profit rates by restricting price increases to less than the rate of inflation. As a result, return on capital in the U.K. pharmaceutical industry has declined to 10 percent, less than half of the 21 percent that is allowed under the PPRS. Domestic profits have declined to 4.5 percent of sales.
In the past, the British government imposed a 2.5 percent rollback of all drug prices, banned access to certain new drugs and imposed a cut in the prices and profits of innovative drugs. Companies exceeding negotiated rates of return must pay fines and reduce prices. According to a research analyst with the Association of the British Pharmaceutical Industry, British drug concerns reacted by shifting nearly $1 billion a year in R&D to their U.S. operations.37
The impact of these changes has affected innovation overall. In 1988 three of the 10 best-selling new products worldwide came from the United Kingdom. By 1992 the U.K. had only one of the top 10. Today, U.K. companies have no drug among the top 10. The United States has all 10 best-selling drugs worldwide.
Further, the PPRS has a built-in bias towards larger firms. Biotechnology companies find it difficult to attract investors because the financial rewards the PPRS allows for large-company R&D (a maximum of 21 percent return on capital) are not high enough for most small companies, which depend on breakthroughs to offset the risks of drug development.
"The United Kingdom had three of the 10 best-selling new drugs worldwide in 1988 -- but it has none today."
Case Study: Germany. The German Health Ministry initiated efforts to control drug costs in 1989 by limiting what public health plans paid for drugs and which drugs would be eligible for reimbursement. If a drug's price exceeded the government limit, the patient had to pay the difference. In 1993 the government mandated a 5 percent cut in drug prices and slashed what the German health authority (the Krankenkassen) could spend on drugs by nearly 10 percent. Doctors have been placed on drug budgets and if they go over have to pay the excess out of their own fees. Sales fell at the seven largest research-intensive drug producers by 16.5 percent, while generic sales increased by 36 percent.38 As a result, at least 126 pharmaceutical firms cut their R&D investment, 40 percent by 10 to 30 percent and 22 percent by a third or more.
Case Study: France. The Ministry of Health in France controls the introductory price of each product, controls subsequent price increases and holds down prices regardless of value. As a result, France has some of the lowest drug prices in Europe. It also has one of the worst records in developing innovative products that can compete globally.
The most successful companies in France are firms that produce and market copycat drugs or mere palliatives. Innovators are punished with artificially low prices that favor companies that produce low-price drugs without regard to their drugs' therapeutic value.
The Rationale for Price Controls. The conventional wisdom is that price controls encourage companies to focus their resources on developing a blockbuster.
As this overview suggests, such a convention is not wisdom at all. Price regulation rewards incrementalism and punishes risk taking, particularly if prices and access to new drugs are regulated. Without innovation, a country's pharmaceutical industry cannot compete globally and its biotechnology industrial base cannot develop rapidly. That is one reason the European Community is considering ways to do away with price controls.