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Q: should policymakers trust the free market to meet urgent demand for prescription drugs
by Ilana Mercer , Alan Sager , Deborah Socolar YES: The forces of supply and demand will lead to higher production and lower cost for the drugs. A coalition comprising roughly 22 U.S. states from the Pacific Northwest to New England has been organized to "bring about fair prescription prices" for people who do not qualify for Medicaid rates. The states are looking for inspiration from Vermont, Maine and New Hampshire, which are in the process of aggressive legislation aimed at explicit price regulation for the benefit of a segment of the voters saddled with out-of-pocket prescription expenditures. To "extend lower drug prices to people who are ineligible for Medicaid," Maine, in particular, has been extracting discounts from drugmakers by threatening to cap their prices. The euphemisms for this elaborate wealth-distributing scheme run the gamut from "fair prices" to "discounts" to "rebates." Some representatives even claim that they simply are asserting and experimenting with states' rights. Never one to complain about devolution of powers from Washington to the states, I somehow have a hard time seeing how the doctrine of states' rights extends to using the force of the law to plunder the property of individuals from the pharmaceutical sector. On the federal level, Tommy Thompson, the secretary of Health and Human Services (HHS), has been setting the pace as far as strong-arming the pharmaceutical industry and tinkering with the economy. Thompson threatened to bust the patent for the anthrax-fighting drug, Cipro, if Bayer AG did not lower its price for its most powerful customer, the U.S. government. The Bayer monopoly price of $4.67 per Cipro pill remains unchallenged. In the absence of generic competition, the product's high price has not forced a voluntary market adjustment on the seller. Bayer's typical rate for the government is $1.77 per pill, and Thompson knocked that price down to 95 cents a tablet. Thompson's tinkering is intended to bolster the national pharmaceutical emergency stockpiles. The states, for their part, are busy robbing Peter to pay at least 13 million voting Pauls who demand a discount on medication. Tendentious interventionists will depict Thompson and the states as laboring to correct the wayward free market. The truth, very plainly, is that where there is an alleged "market failure," it is safe to say that it is because of government incursion into the economy. The energetic price-fixing and stockpiling from our bureaucrats are ad hoc responses, not to a market deficiency but to deficiencies brought about by ongoing policies of intervention in the economy. Behind the scarcity -- or exorbitant prices of drugs -- is the regulator's heavy hand. The Cipro addle illustrates the point. The government has been asking Americans not to stockpile the medication but to rely on the government's calculus of probabilities: If the crunch comes, the government promises to be able to treat 12 million people for 60 days of incubation. And never mind that the market has cheaper alternatives. Only in a command economy does government dictate when the demand for a good has been sated. In a free market, consumers direct supply and demand. And in a free market, increased demand leads to increased supply, as producers compete with one another to satisfy buyers. When the demand for Cipro or any other drag has approximated its supply, buyers -- not the government -- will have indicated their needs have been satisfied. If every single paying American wishes to store a smallpox vaccine or secure a course of Cipro, if only as a psychological antidote, why not? The recent disastrous events have made this particular resource scarcer at the current price because, among other reasons, more people are bidding for Cipro. But even so, Bayer's promise to triple the production of Cipro -- cranking out 200 million tablets during the next three months -- may do little to satisfy a demand driven by almost that many Americans. This is because we do not have an unhampered market. How would consumer demand have been heeded had the market not been hampered? The same events that hitherto have occurred would have unfolded; the sudden urgent demand for the drug would have been followed by a shortfall of supply. Large demand and short supply initially would send the price of Cipro or any other drag rocketing. At this stage, demonstrators would take to the streets, riding the same old ass and hollering, "Profits equal plunder." Our bellicose collectivists never understand that our very lives depend on the ability of the manufacturer to read and act on vital market signals. Surging profits in an unhampered pharmaceutical market would signal to the many drugmakers that it's time to enter into Cipro production. All these processes have transpired, save one: Drugmakers are not permitted to respond to one of the street signs of the free market -- profits. Patent law prohibits pharmaceutical companies from competing for Cipro market share, and in the process of satisfying the buyer's demand for it, also creating competition and dealing a blow to the Bayer monopoly price tag. Whether one thinks that granting to an inventor a near 20-year monopoly on the manufacture, use or sale of a product is the right thing to do is quite apart from acceding that a patent places a barrier on entry into the market. This barrier is the essence of monopoly. Capturing a large market share by pleasing consumers does not a monopolist make. But obtaining from government a grant of privilege that gives the profit seeker the legal power to restrict access into the market, so that he is undeterred by competition, qualifies. Any coherent explanation for the shortages or elevated prices of certain drugs must proceed from the understanding that patents allow the manufacturer to create a scarcity of the product by restricting its supply in order to raise the price. As the actions of Thompson and his compatriots at the state level demonstrate, the reality of government-created shortages is ameliorated either by government fiat or, in this instance, if Bayer relents and licenses the drug to generic manufacturers. Granted, Food and Drug Administration (FDA) regulations play a role in limiting our choices and restricting competition in the market. Getting a new drug approved today costs about $500 million and takes approximately 10 years. The sclerotic FDA does not, however, explain why, once a shortage has occurred in an already-approved drug, the self-regulating market mechanisms cannot kick in to overcome the scarcity. Patents explain this. The Centers for Disease Control and Prevention have expanded the range of anthrax prophylactics to include doxycycline and others. The pressure has been somewhat lifted off Cipro as the first-line agent of choice in treating anthrax. It would, however, be a mistake to consider the case of Cipro a mere fluke; it's a harbinger of things to come. "Public health" is not safe so long as companies receive from government a protracted monopoly on the manufacture, use or sale of a product. The immediate upshot of government stockpiling of these compounds is to make them less available to the ordinary person and to increase prices throughout the drag market. Subsidized government programs themselves spur "a significant purchasing of drags" confirms the Canada-based Fraser Institute, and "can increase prices in the rest of the market" Drag manufacturers respond to the fixing of prices by government by recovering their legitimate or alleged costs from nongovernment buyers. And wouldn't you know it: The not-quite-invisible hand of government is implicated in the very prescription-drug prices the states now are attempting to "fix." Discussion of prohibitive prescription costs is a perennial cue for the media (including a 1999 CBS 60 Minutes segment) to dust off some American seniors and follow them en route from Maine into Canada to fill their life-saving prescriptions. The story's claim: Victimized by the "pharma-villains," the only way many American seniors can get affordable, life-saving medication is this pilgrimage to Canada, where price controls are hale and hearty. Ironically, the trek to Canada is unnecessary. American seniors can get similar gains by "bargain hunting" at home, according to researchers at the Fraser Institute. Still, prescription-drag prices generally are lower in Canada than in the United States. Simple ignorance of consumers partly explains the rush to adopt Canadian-style regulation of drag prices in states such as Maine, Vermont and others. With Canada's declining standard of living, a depreciating dollar and poor productivity, no wonder that Canada has been called an honorary member of the First World. Average prescription-drag prices are indeed lower in Canada, but then again goods and services are generally cheaper in poor countries. "Low drug prices reflect Canada's low standards of living" explains the Fraser Institute's John R. Graham. "They are the marketing response of the pharmaceutical companies to declining incomes." Manufacturers will adjust prices to keep selling in a poorer country. Big government is in vogue. A bureaucracy that is enjoying a popularity windfall is on the verge of convincing Americans a Canada-style price-control regime is in their best interests. If Americans wish to emulate Canada's Patented Medicines Prices Review Board, let them be forewarned that, in Canada, the board ensures that price increases follow a complex guideline in which supply and demand has no role. The immediate effects of Canada-style price controls in the United States will be high prices for generic and older patented drugs and little competitiveness in the price of innovative drugs. Because price controls quash the ability of the manufacturer to increase his prices in response to high demand, price controls also sever the link between buyer and manufacturer. This translates into the manufacturer's inability to give us what we want. Are Americans ready, like their flaccid Canadian neighbors, to allow government to dictate their needs? In the long run, price controls will create the incentive to over-consume. For drag manufacturers, price controls will reduce the incentive to invent, meaning fewer breakthrough drugs for patients. The prognosis: a spiral of demand and a diminishing supply, to say nothing of less flexibility to deal with crisis situations. We have come full circle back to the free market. NO: Drug manufacturers seek to maintain artificially high prices. High prescription-drug prices are a national plague. Two symptoms recently were in the news. Domestically, the U.S. government should have found it straightforward to buy adequate stockpiles of antibiotics to cope with anthrax. Instead, Bayer's demand for high prices and windfall profits for Cipro sparked dramatic legal and financial tensions. Internationally, high U.S. drug prices will cause discord in the forthcoming international-trade negotiations. What has not been in the news lately, though, is the pain that excessive prescription-drug prices inflict on ordinary Americans of all ages every day: * Americans pay the world's highest prescription-drug prices -- prices that are not sanctified by a free market or by actual costs of production. If we paid the prices that the world's drugmakers accept in Canada for the same products, we would save almost $40 billion this year alone. * American spending per person also is the highest in the world, averaging above $500 this year. Prescription-drug costs nationally total about $160 billion in 2001 and are doubling every five years. * Many people can't afford needed medications. Seventy million -- one American in four -- have no prescription-drag insurance. Most are under age 65. Millions of others have inadequate coverage. Insurance pays only one-half the cost of drugs bought by U.S. seniors. * Soaring drug costs undermine health insurance, pressing employers to cut their contributions to employee plans and eliminate retiree coverage. Medicare health maintenance organizations (HMOs) are dropping drug benefits or raising premiums. * High prices lead HMOs and insurers to try to save money by restricting use of expensive drugs, by raising copayments or by instituting restrictive formularies. These can deny patients the medical benefits of the most effective drug for needed treatment. High drag prices confront our nation with three choices. The first is to continue to let many people suffer and die for lack of available medications. That is starkly intolerable. The second choice is to pay much more money to drugmakers. That is unaffordable. For now, Congress effectively has abandoned plans to spend $300 billion over 10 years to subsidize a new Medicare prescription-drug benefit because it would be inadequate -- the premiums would be too high and the coverage too low. Unwillingness to legislate lower drag prices and to cut drugmakers' windfall profits was one of the main reasons. The third choice is to change how we do business. That is unavoidable. Sadly, it won't be legislated this year. The rule of "the bill that will pass won't work and the bill that can work can't pass" still is in force. A number of current proposals look good on television but won't work. One is the drug-discount card. Whether offered by President George W. Bush or former congressman Joe Kennedy, these promise substantially bigger discounts than they can deliver. And they mainly would squeeze pharmacies -- bypassing the drugmakers that garner three-fourths of the revenue. Another is importation of drugs from Canada. Americans can ask their doctors to fax prescriptions to Canadian retail pharmacies to enjoy regulated prices, but the world's manufacturers would dry up supplies in Canadian warehouses if our government tried to import drugs wholesale. Yet another proposal is voluntary drug insurance. Even the insurance industry doesn't want to offer it because the people who need costly drags predictably will sign up, sending premiums into orbit. Fights to shorten patent duration and efforts to lower prices on drags developed with dollars from the National Institutes of Health would deprive drugmakers of revenues they claim they need to finance research and profits. Those claims have to be addressed head-on, not subtly or indirectly. Drugmakers wrongly claim high prices are good for us. They threaten that government efforts to cut prices would cripple research. But industry insistence on high prices -- and its campaign contributions and lobbying to block reasonable reform -- is the real threat to research. Many Americans worry that research is pointless if they can't even afford today's drugs. Worry soon will turn to anger. Anger will elect an impatient Congress that will slash drugmakers' revenues. And that would harm research. Manufacturers also claim that drugs don't cost too much. They wrongly insist that a free market sets drug prices. There is little of a free market for prescription drags. Patents grant drugmakers monopolies that boost prices. Drugmakers merge at alarming rates. In six of 10 classes of drugs, only four manufacturers control more than 80 percent of the market. And manufacturers fight fiercely to delay competition from low-cost generics. Without a free market, the alternative to careful government action is anarchy -- with soaring prices, profits, pain and anger. Ironically, only government action can give us the low prices that would prevail in a free market. Congress has done little to protect the nation from artificially high drag prices. Instead, it has protected itself by obtaining deep discounts for the military and veterans, plus lower discounts for Medicaid. State governments have been first to focus on prescription-drug problems. States are more financially exposed to paying the cost of drags and more politically exposed when angry patients cannot afford their medications. Many state Medicaid programs are besieged by soaring drug costs for patients with chronic illnesses. Further, decades ago states began subsidizing drug purchases, especially for low-income seniors. Many state legislators face little political opposition and so have less reason than their federal counterparts to fear drugmakers' campaign contributions to opponents. In 2000, states began trying to cut drag prices. Two examples: * It probably is no accident that Maine, with the nation's oldest drug-subsidy program for seniors, was the first to legislate serious drag-price cuts. Dozens of other states have been considering similar approaches, but a lawsuit by drugmakers effectively has frozen implementation of the Maine law, pending a Supreme Court decision. * Vermont enacted a law that would let people with incomes up to three times the federal poverty level pay Medicaid's discounted prices. Drugmakers have tied this up in the courts also. If allowed by the courts, some state approaches will work and others will not. Lessons from the states will help to guide future federal action. While states tinker, we have to sketch a national prescription-drug peace treaty that works for all stakeholders. States have pointed to the usefulness of combining subsidized coverage with price cuts. The challenge now is to make drags affordable for all while rewarding drugmakers' research into breakthrough medications and providing profits commensurate with risks. Manufacturers charge more for drugs than they need for research or profits. We can lower prices to make medications affordable for all without hurting drugmakers if we act carefully. This is largely because -- once the research is performed and the factories are built -- the actual incremental cost of making more pills usually is very low. There is a moderate middle ground between industry's extreme demand for unlimited money today and the backlash of extreme price cuts tomorrow. Getting there requires public action to negotiate a prescription-drug peace treaty that protects both patients and industry. First, cut prices for all patients, perhaps to Canadian levels or those already paid by the federal government for the military and veterans. If nothing else changed, drugmakers would suffer an immediate revenue loss of almost $40 billion annually. But, second, much or most of that lost revenue quickly would be restored through higher private-market volume in response to the price cuts. Third, because many patients could not afford even the discounted prices, they would be helped by public subsidies. Government, now more able to afford to expand coverage, would guarantee to replace the remainder of the $40 billion in lost revenue. Fourth, public payments also would be needed to cover the extra cost of manufacturing and dispensing the additional drugs. We estimate this would total about $9 billion annually for up to 1 billion additional prescriptions -- a one-third increase. Again, the low marginal cost of producing more medications makes this possible. The results? Americans can afford to fill all the prescriptions our doctors write, with only a small rise in total spending. Drugmakers' profits and research are protected. They can stop threatening that only high prices can finance the cures of the future. This sort of peace treaty will make today's drugs affordable for all. It does more. It provides a breathing space in which to plan how to make tomorrow's costly new drugs dumbly affordable as well. Three steps are vital. One is more-careful assessment of the added value of each new drug in comparison with existing remedies. A new and objective clearinghouse is needed to collect information and inform doctors and patients of the best evidence on the value of each drag. Second, this would substitute for the drugmakers' current marketing campaigns, which are costly and wasteful -- and often misleading. Today, large drugmakers' spending for marketing is as much as double what they spend on research. (Even their profits run 50 percent more than research.) A third step is to design, test and put in place clear and fair rewards for drugmakers. Today, 40 cents on the research dollar is largely wasted on copycat drags. Tomorrow, breakthrough drugs would be assured high profits. Winning affordable prescription drags for all Americans while protecting research probably is the easiest job in the United States. That's because we already spend enough to buy the drugs we need. The political obstacles are real today. But soaring drug spending will heighten patients' anger and insecurity, which will overcome those obstacles some time in the next few years. When the political demand for action arises, the federal government will need to know what to do. Encouraging continued state tinkering and testing will provide vital ideas and experience. Idolizing the golden calf of an unachievable free market for drugs is bad economics. Shoehorning prescription-drug realities to fit the theories of a flee market is bad medicine. Mercer is a free-lance writer who has written for many publications in the United States and Canada. Her commentary is posted regularly on the Website of the Ludwig yon Mises Institute and at www.ilanamercer.com. Sager and Socolar direct the Health Reform Program at the Boston University School of Public Health. The program prepares ways to cope with crises in health care.
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