Price Controls For Drugs

By Paul H. Rubin

The Clinton health plan proposes several forms of price controls on pharmaceuticals sold in the United States, including a new bureaucracy (the Advisory Council on Breakthrough Drugs) that will determine if drug prices are “reasonable.” Clintoncare’s pricing proposal embraces classic price controls, and will generate all the unfortunate consequences of price controls. Proponents use specious arguments to justify these controls.

Some critics of the pharmaceutical industry use their accounting records to claim that there are large excess profits being generated. However, the Office of Technology Assessment has shown that the return on equity for the pharmaceutical industry is only slightly higher than the average for all industries. This is because accounting figures do not properly reflect large investments in research and development. Were the high costs and risks of drug development taken into consideration, even these small differences in industry averages would disappear.

Other critics argue that drug prices have increased at a faster rate than the prices of other consumer goods. However, research by well-known economists at major universities has revealed numerous biases in the official reporting of drug prices, making this assertion misleading. For example, the official figures treat a generic drug as a separate drug. The introduction of a generic drug causes a drop in real costs to consumers, but the official data do not reflect this. The official data also generally use list prices, though more pharmacists and pharmaceutical companies are beginning to discount the cost of drugs. Taking these and other biases into account, it is likely that drug prices rose less than prices of other medical services in recent years.

Proponents of price controls argue that U.S. drug prices are higher than in other countries, but these claims are also based on misleading data. Research by Patricia Danzon of the University of Pennsylvania has shown that U.S. prices, properly measured, are higher than in some countries, but lower than in others. Moreover, the higher costs of doing business in the U.S. (including long delays in drug approval and increased product liability costs) account for most of those differences.

Some complain that too much pharmaceutical research is on “me too” (copycat) drugs, but these drugs often improve upon existing drugs.
Moreover, it is the creation of competitive drugs that puts downward pressure on drug prices. It seems inconsistent to complain that prices are too high on one hand, and on the other insist that there is too much imitative research that will ultimately lead to greater competition.

Do pharmaceutical companies spend too much money on promotion and not enough on research and development? This suggestion is flawed for two reasons. First, while research and development are necessary for discovering new drugs, these discoveries are worthless unless physicians learn enough to prescribe them, or consumers learn enough to request them. This is the role of promotion. Second, if physicians do not prescribe drugs, pharmaceutical companies do not make money, and there are fewer resources for research and development.

This brings us to the important policy question: How much research and development do we want from the industry? Americans are accustomed to routine announcements of new therapies, and the pharmaceutical industry risks large amounts of capital to develop new medicines. If shifts in public policy cause a reduction in drug companies’ profits, they will also reduce the means for investment in breakthrough research.

Anticipation of health “reform” has already reduced the value of pharmaceutical stocks by at least $90 billion, and caused 36,000 layoffs in the industry. This reduction in value decreases the return on investment, and will have the inevitable effect of diminishing research and development expenditures. Fewer employees mean fewer researchers for new drugs. Reductions in innovation are particularly unfortunate at a time when new biological technologies offer the hope of major breakthroughs.

We may decide as a society that we are willing to live (and die) with the finite set of remedies already available, and that a drastically reduced rate of new drug innovation is in our best interest. However, if we make this choice, it should be a conscious, informed choice, not the result of a witch hunt aimed at the pharmaceutical industry. Those who advocate price controls for drugs should explicitly indicate the choice we face, and see if Americans want to trade reduced prices today for reduced new therapies tomorrow.

Since I will die of a condition for which there is now no cure, I would like to see more research. If you think about it, you might agree.


Paul H. Rubin is Professor of Economics at Emory University. He is a member of the Board of Academic Advisors of the Georgia Public Policy Foundation, an independent, non-partisan research organization based in Atlanta, Georgia. The Foundation promotes free enterprise, limited government and individual responsibility.

Nothing written here is to be construed as an attempt to aid or hinder the passage of any bill before the U.S. Congress or the Georgia Legislature.
© Georgia Public Policy Foundation (March, 1994) Permission is hereby given to reprint this article, with appropriate credit given.

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