Ten Myths about the Market for Prescription Drugs
Will the U.S. See Price Controls?
The Clinton administration's proposal to control prescription drugs for the elderly has much in common with the French system of setting pharmaceutical prices and reducing the price of innovative drugs, as well as the German system of deemphasizing innovation in favor of generic drugs. Under the administration proposal, private U.S companies that administer drug benefits for the elderly and individual seniors could buy drugs at prices negotiated for the entire program by the federal government.
Is it possible that such price regulation in the United States won't discourage innovation? After all, the industry has gone through three years in which price increases have declined and even stagnated after discounts, price freezes and generics are taken into account. Managed care companies increasingly favor lower-priced drugs and now examine the cost-effectiveness of new drugs before paying for them. In addition, the industry has paid nearly $1 billion a year to the federal government in Medicaid rebates. Yet R&D spending has increased, not decreased. If both the pharmaceutical and biotechnology industries still are thriving and investing in innovative new products, why would government regulation over the prices of those new products make any difference?
"Because of the time lag between drug discovery and introduction, the market will not feel the full impact of the government price control policy for years."
First, because of the time lag between drug discovery and introduction, the market - physicians and patients in particular - will not feel the full impact of the policy for years. The initial cuts would come in the riskiest research for the hardest-to-treat illnesses. Then the market value of pharmaceutical and biotechnology stocks would decline. As cash flow declined, so too would R&D. For biotechnology companies, the decline in cash flow - and risk capital used for R&D - is dollar for dollar. Only breakthrough products yield robust earnings. A study by Henry Grabowski and John Vernon estimates what would happen if the government cut the price of breakthrough drugs by 23 percent - essentially establishing a break-even rate of return on R&D investment: cash flows for the best-selling drugs and biotechnology therapies would fall below the total cost of R&D. The result, particularly for biotechnology companies, would be devastating.39
Second, under the president's plan, the government would cover up to 50 percent of all prescription drugs purchased. As the largest purchaser of drugs, it would have immense, near monopsonistic power to force prices down, extract discounts and pay only for drugs that met its terms. Government could single-handedly create far more pricing pressure than any number of managed care organizations.
Finally, price controls represent not merely an extension of market pressure but a fundamental shift in values. Controls substitute a political process for the marketplace. For controls to work, individuals would have to adhere to governmental or bureaucratic decisions. Decisions by physicians, pharmacists, medical researchers, companies and patients would be replaced by those of a few "experts."
"Price controls represent not merely an extension of marketplace pressure but a fundamental shift in values."
Price controls supplant market forces and replace good health with cost containment as a goal. Lower prices send a signal that innovation will not be rewarded with higher returns. By limiting rewards and discouraging investment, price controls limit innovation. As Dr. Judith Wagner, a senior associate with the Health Program at the Office of Technology Assessment has noted, "an administrative process for controlling drug prices would add a new source of uncertainty - one that would not be resolvable until all the money has been spent. Consequently, investors would be more hesitant to commit early R&D money...."40 More recently, in discussing the Clinton drug plan, Barbara Ryan, one of Wall Street's leading pharmaceutical industry analysts, noted that "the specter of significant price controls has been sufficient to substantially reduce the appeal of drug stocks to investors. We expect this to persist throughout the election process in 2000. Drug price controls would substantially reduce pharmaceutical company investment in R&D, which would effectively stall the progress made in significant therapeutic advances. There is a direct relationship between profitability and the willingness to invest in R&D."41
NOTE: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any bill before Congress.