* "negotiating" drug prices
Topics: Health
05 Dec 2006
From: Ervan Darnell
In another forum, someone argued in favor of Congress
"negotiating" drug prices for Medi* instead of paying market
rate. My response to why this a bad idea, a rebuttal article from
an outside source (New York Review of Books), and my subsequent rebuttal
to that article follow.
Allowing Medicare to negotiate drug prices would be tantamount to price
controls. Where states have done this, they have gotten away with it
simply by transferring the cost to the private market, or other states.
There is no real savings in such a move. Were the federal government to
do so, especially given that many of the drugs in question are sold
almost entirely to the Medicare market, it would simply be a way to kill
research for future drugs to subsidize current ones. That's a bad trade
off. If we are to subsidize drugs for seniors, the only fair thing to do
is to pay market rate.
The argument for drugs outside of patent protection is bit better.
Even still, this will lead to price controls and the further
socialization of health care. If the government negotiates Lipitor to
cost $5 per pill after destroying all research, next year it will demand
$4.50/pill and Pfizer will not be able to manufacture it profitably.
Then comes the price control forcing them to manufacture at cost (just
like Medicare now indirectly forces doctors to provide services at cost,
or less). When Pfizer cannot meet that target, the government will take
over the manufacture of it, or find some way to violate the IP, thus
discouraging production.
Another possible outcome is the Pfizer lobbyists capture the members of
the drug price committee and make sure that the negotiations for any
Pfizer-competitive drugs are such that they are never purchased.
The article used in rebuttal (and much more at the link):
http://scholar.google.com/scholar?hl=en&lr=&safe=off&q=cache:BNK_kOz7OVYJ:www.australianinterest.com/NYRB.pdf+author:%22Angell%22+intitle:%22The+Truth+About+the+Drug+Companies%22+
In the past two years, we have started to see, for the first time, the
beginnings of public resistance to rapacious pricing and other dubious
practices of the pharmaceutical industry. It is mainly because of this
resistance that drug companies are now blanketing us with public
relations messages. And the magic words, repeated over and over like an
incantation, are research, innovation, and American. Research.
Innovation. American.
It makes a great story.
But while the rhetoric is stirring, it has very little to do with
reality. First, research and development (R&D) is a relatively small
part of the budgets of the big drug companies—dwarfed by their vast
expenditures on marketing and administration, and
smaller even than profits. In fact, year after year, for over two
decades, this industry has been far and away the most profitable in the
United States. (In 2003, for the first time, the industry lost its
first-place position, coming in third, behind "mining, crude oil
production," and "commercial banks.") The prices drug
companies charge have little relationship to the costs of making the
drugs and could be cut dramatically without coming anywhere close to
threatening R&D.
Second, the pharmaceutical industry is not especially innovative. As hard
as it is to
believe, only a handful of truly important drugs have been brought to
market in recent
years, and they were mostly based on taxpayer-funded research at
academic
institutions, small biotechnology companies, or the National Institutes
of Health (NIH). The great majority of "new" drugs are
not new at all but merely variations of older drugs already on the
market. These are called "me-too" drugs. The idea is to grab a
share of an established, lucrative market by producing something very
similar to a top-selling drug. For instance, we now have six statins
(Mevacor, Lipitor, Zocor,
Pravachol, Lescol, and the newest, Crestor) on the market to lower
cholesterol, all variants of the first. As Dr. Sharon Levine, associate
executive director of the Kaiser Permanente Medical Group, put it, If I'm
a manufacturer and I can change one molecule and get another twenty years
of patent rights, and convince physicians to prescribe and consumers to
demand the next form of Prilosec, or weekly Prozac instead of daily
Prozac, just as my patent expires, then why would I be spending money on
a lot less certain endeavor, which is looking for
brand-new drugs?
[4]
Third, the industry is hardly a model of American free enterprise. To be
sure, it is free to decide which drugs to develop (me-too drugs instead
of innovative ones, for instance), and it is free to price them as high
as the traffic will bear, but it is utterly dependent on
government-granted monopolies—in the form of patents and Food and Drug
Administration (FDA)–approved exclusive marketing rights. If it is not
particularly innovative in discovering new drugs, it is highly
innovative— and aggressive—in dreaming up ways to extend its monopoly
rights
The argument in the article is advocating price controls, not merely
heavy handed negotiation. It's not arguing that there is some market
failure that leads to inefficient pricing, it's arguing that drug
companies don't deserve their profits. Despite arguing for price
controls, it doesn't offer how that will help anything. It's the old
liberal fantasy that profits are evil and if we outlaw profits (or
"government negotiates" prices) everything will be reasonably
priced.
Taking the article's arguments in turn:
1) R&D is about 10-20% [0] of drug company expenses. 10-20% is not
"relatively small" in my book, but the author doesn't even
bother to tell us how small, just some diminutive phrase. R&D is also
the most discretionary part and the first to be cut, so the real harm is
not just that a 25% price cut will lower R&D by 25%, but more like
50-90%.
[0]
http://en.wikipedia.org/wiki/Pharmaceutical_company#Industry_revenues
2) She writes that pharmaceuticals make almost as much as
big oil. Big oil makes about 5% [1]. I do believe pharmaceutical profits
are higher than 5%, but this simply shows she is playing very loose with
the numbers. Okay, she says "crude oil" and not "big
oil", which sounds a bit like cherry picking the data.
Here is a source that lists profits as 17% [2]. That's high, but not
huge, and even if we could cut that to 5% (a normal profit margin), that
12% decrease would not pacify the price-regulating liberals for one
month, nor really solve the high-cost of drugs from a consumer's
perspective.
Even 17% is not as high as it seems. High risk and high profits go
together. It has to work that way. Drugs are high risk because the
R&D might not work out and they are doubly high risk because some
unknown medical risk may later lead to a plague of lawyers and multi-$G
pay outs, much of which sadly returns to Democratic campaign
contributions as rewards for creating bogus tort in the first place.
Regardless, it's high risk. None of the investors in my company would
accept anything so low as 17%. 17% is not an unreasonable risk premium
given the nature of the business.
Third, the lag time between drug creation and profit from the drug is
substantial. Profits need to be averaged over the long run, and current
profits are based on forward-looking costs, e.g. "According to a
study released in late November by PricewaterhouseCoopers, R&D costs
at the pharmaceutical companies have more than doubled [to
>$650M/drug] over the last seven years and are continuing to rise.
Meanwhile, sales are lagging and product lifecycles are shortening...
" [3]
Fourth, if you still think it's too high, the answer is to lower barriers
to entry (like extortionist FDA testing procedures that make it near
impossible for new companies to compete). It's a perfectly good general
argument: if the price is too high why don't you invest in a company with
a method for producing and selling it for less? There are two choices,
either the price is justified for reasons the author does not understand
or the government is prohibiting competition. Neither argues for price
regulation.
While I'm talking about disincentives, the disincentive of having some
future Congress choose an arbitrary price for the product you are
developing now is a huge disincentive to researching it in the first
place. I want at least a 50% profit margin just to cover the political
risk.
[1]
http://www.cato.org/pub_display.php?pub_id=5352
[2]
http://www.cmaj.ca/cgi/content/full/171/12/1451
[3]
http://www.destinationkm.com/articles/default.asp?ArticleID=448
[ not sure of reliability of this source ]
3) The IP system is broken for rewarding non-invention: true. In other words the law that the government creates is bad, but the author blames private enterprise and wants more government after confessing it's the government that is broken. In any case, fixing the patent system is independent of price controls.
This is all backward from the word "go". Consumers buy "me too" drugs because the government has insulated them from the prices either by direct insurance or mandates on private insurance. For the same personal cost, why not get the latest and greatest? Make co-pays much higher and proportional so consumers have some incentive not to get the "me too" drugs, and restore some elasticity to the system. Then drug companies would become more interested in truly novel products than "me too" ones, and consumers save money along the way.
4) The author believes that IP==monopoly and that it is unjust that people be rewarded for their intellectual labor. I just hope I get paid this month before all of my labor is stolen by the socialists. Even were the government to confiscate the IP by invalidating the patent, it would be just another way of destroying R&D.
5) "If prescription drugs were like ordinary consumer goods, all this might not matter very much. But drugs are different. People depend on them for their health" is exactly the liberal liturgy from the Bible of Marx. The question is not what's important, the question is what works. The liberal perspective seems to be that markets fail and socialism works, but we'll tolerate markets anyway as a courtesy to people who play with money for buying cocktails and plastic dolls. If socialism works and markets fails, there should be no objection to communism in all things, since it works after all. But this has it all backwards, we need free markets for health care exactly because markets work and socialism does not, not because bodegas are cute when selling fruit roadside.
This reflects my first comment: the author is not arguing for improved negotiations, but making an appeal for a government takeover, or at least heavy-handed regulation.
The Dem position is straight forward here: take money from likely Republicans (stock holders) by price regulation, take future medicines away from people who don't know what they have lost, and give cheap drugs to likely Democratic voters. The Democrats came to office claiming to want to clean up corruption. Their polices are a multi-billion bribery scheme that puts Abrahmof to shame.
-------------------
If you think this is really about negotiating power and not price controls, the problem is already solved: Kaiser. They are big and have negotiating power. They have cheap drugs for members too. Join them if you think that's a winner. Give Medi* recipients their subsidy as an HMO voucher and let them choose group rates.
-------------------
Where I would agree with liberal policies is that government funded research has a place. The value of the free flow of information (versus NDAs everywhere) is huge. Granting exclusive marketing rights to discoveries is also a reasonable way to commercialize a product, but the IP rights should be limited in that case.
====================================================
Ervan Darnell
ervan@kelvinist.com http://www.kelvinist.com
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