NCPA - National Center for Policy Analysis


December 18, 2006

In an effort to bring down drug prices, the Democrat-controlled House plans to repeal the ban preventing Medicare from negotiating directly with pharmaceutical companies.  However, there are several good reasons why allowing the government to negotiate with pharmaceutical companies may not lead to lower prices than those achieved by private drug plans, say Alain Enthoven and Kyna Fong, both of the Graduate School of Business at Stanford University.

Rather than market share, a party's bargaining power is determined simply by its ability to say no -- to walk away from the table without an agreement.  If the government acts as one large buyer for Medicare, drug companies are not able to offer discounts to the government as large as they previously offered to some individual plans.  This leads to higher prices.

According to research by Yale University economist Fiona S. Morton, the 1990 Medicaid best-price rule has had a small but noticeable effect on the prescription drug prices paid by non-Medicaid purchasers:

  • Prices paid by the public for brand-name drugs with generic competitors have increased an average of more than 4 percent.
  • Price increases have been highest for drugs for which Medicaid purchases comprise a larger share of sales.
  • Drug discounts to non-Medicaid buyers have fallen.

In the United States, the Department of Veteran Affairs' tight control over drug costs is often held up as a model for Medicare to follow.  However, it the main tool the VA employs to control drug costs is restricting the set of drugs that are covered.  As a result, less than one-third of the drugs available to Medicare patients are available to VA patients.

Empowering the government to negotiate with pharmaceutical companies is not necessarily equivalent to achieving lower drug prices.  In fact, neither economic theory nor historical experience suggests that will be the outcome, say Enthoven and Fong.

Source: Alain Enthoven and Kyna Fong, "Medicare: Negotiated Drug Prices May Not Lower Costs," National Center for Policy Analysis, Brief Analysis No. 575, December 18, 2006.

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