January 4, 2005

Health Care & Big Pharma IV: Some Solutions, No Single Answer

Marc Comtois
PROEM: This is a continuation of a series on Health Care & Big Pharmaceutical companies. For more, see the Introduction, Part 1, Part 2 and Part 3.

As Justin recently pointed out
There are a number of topics in which we find other countries getting away with practices that would have dire consequences were the United States to emulate them (the atrophied militaries of Europe come to mind). That, it seems to me, is the price that the U.S.A. pays for being the U.S.A. The question of the century may very well be whether we're a sufficiently mature people to acknowledge and accept it.
Within this context, the question Americans face when it comes to drug prices is whether we are willing to continue to subsidize the rest of the world. It is becoming increasingly apparent, to those inside and outside of the U.S., that we are not. Unfortunately, this deeper issue has been masked by the prospect of a short term solution: the importation of cheaper drugs from foreign countries. What has not been discussed in this debate is that the short term savings accrued by purchasing cheaper drugs from other nations (who impose price controls) will eventually disappear as normal market forces gradually come into play.

But are drug prices really that high in the U.S.? A recent study concluded that, while the U.S. does pay more for drugs than other countries,
the differences are not nearly as large as they appear at first glance. The higher prices in the United States are concentrated among a subset of brand-name drugs and among those without insurance covering drugs. Some U.S. health plans obtain price concessions from manufacturers similar to those obtained by national governments. (1)
While the particular point regarding specific drugs may be true, it is this “sub-set” of brand name drugs that are those most desired by Americans and are attractively priced overseas. Further, even if insurance companies do bargain with pharmaceutical companies for lower prices, the current focal point of controversy is concerning those whose drugs are not covered by insurance. Here in Rhode Island, the quick solution to the dilemma has been to approve the importation of cheaper drugs from Canada. Perhaps a better and longer-term solution would be to network the uninsured and those without prescription drug coverage so that their purchasing power would be greater, as proposed by RIPIRG.

It is important to explain that price controls in Europe has fostered a parallel trade market for pharmaceuticals within the European Union.
For many years the varying methods of price control of medicines by national governments in the European Community (and elsewhere) have resulted in wide variations in prices. Parallel traders buy products in low pricing Community countries and sell them, generally relabelled or repackaged, in high pricing Community countries. This practice diverts sales revenue and profits from the manufacturers to the traders, distributors, pharmacists and, in some measure, to the sickness funds and to some patients. While parallel trade appeals to those who gain financially, its basis is a market distortion that poses a significant threat to the future of the research-based pharmaceutical industry.(2)
What many in the U.S. are pushing for is essentially an extension of the European parallel trade market into our country. Under this system, it appears that everyone but the pharmaceutical companies benefits. If it is assumed that “Big Pharma” can currently afford to take the hit, the question that should be asked is: for how long? How long before R&D is insufficiently funded? How long before drug companies determine that broad-based price increases are the only method by which they can continue to finance R&D and maintain a profit motive? The answer is that we are fast approaching this point. Drug companies are aware of parallel markets and have countered with drug price “convergence,” whereby one price is set and charged to all nations. This so-called “euro price” has a negative affect on those who can least afford it.
The primary losers from 'euro' pricing will be consumers in low income countries who will face higher prices or loss of access to new drugs. In the long run, even higher income countries are likely to be worse off with uniform prices, because fewer drugs will be developed.(3)
In Europe, they have come to realize that parallel trade itself is not enough to keep drug prices low. For the first time, these countries are instituting cost-sharing plans (what we would call co-payments) for their drugs. Such was proposed as early as 1997, in a study that
policy should aim to contain growth in pharmaceutical expenses by means specific to reimbursement rather than direct price controls. By encouraging doctors to prescribe and customers to use generics, competition is enhanced to bring down drug prices. More emphasis is being laid by government in educating customers to cost-awareness and cost-benefit ratios with regard to pharmaceuticals.(4)
Key to this program is making consumers and doctors aware of cheaper generic drugs. However, unless co-payments are indexed to actual drug costs, and not just a simple flat-fee, there is no consumer incentive to select a cheaper generic version over an established drug.(5) In Germany,
Starting in 1989, a maximum reimbursement for a given medicine replaced a flat prescription fee. This change in reimbursement exposes the patient to the price of a prescribed product. Using a product-level panel data set covering several therapeutic categories before and after the policy change, I find that producers significantly decrease prices after the change in potential patient out-of-pocket expenses. Price declines are most pronounced for brand-name products. Moreover, branded products that face more generic competitors reduce prices more.(6)
The availability of generic drugs is dependent on patent expiration. Some seek to shorten the length of drug patents in hopes of quickening competition within a given drug class. Others have offered more innovative solutions.
To restore competition to all parts of the pharmaceutical industry, we propose a new institute at the National Institutes of Health that would compete with the private sector for pharmaceutical intellectual property by establishing competition for research and development contracts open to public and private institutions; retain the resulting patents; and grant cost-free, nonexclusive licenses to all qualified producers.(7)
This seems an attractive option that sets up the government as a competitor, not a sole developer, in drug R&D and provides for some measure of free-market development competition. Taking it a step further, some believe that entirely publicly supported research, even if “considerably less efficient on a dollar-per-dollar basis than patent-supported research” would be beneficial.
The main reason for this conclusion is that patent monopolies lead to enormous economic distortions, including expensive sales promotion efforts, research into "copycat drugs," incentives to conceal unfavorable research findings, and other inefficiencies that economic theory predicts would result from a government-created monopoly. The gains from publicly supported research, coupled with a free market in the production of drugs, could reach into several hundred billion dollars annually within a decade.(8)
Thus, government inefficiency, manifested as more tax-dollar expenditure, is deemed an acceptable loss on the way to reducing overall drug costs. The only problem it is rare indeed when a government program becomes more efficient over time. It could be reasonably expected that there will come a point where the government inefficiency would eventually approximate the “losses” from higher drug prices that had been projected and that the sole-source government program was intended to deflect.

It seems, then, that we have a few reasonable, long-term solutions available to us. Yet, these must be weighed against how they conflict with true "free-market" economics, especially business incentives. For we must not forget that pharmaceutical companies are businesses, albeit ones that traffic in goods that are deemed beneficial to mankind. This makes them unique. As the rhetoric has risen, so has the basic assumption that health care, and drugs, are a "right." In such an environment, profit motives and the bottom-line get lost or are deemed inhumane aspects of the conversation. However, profit motive is the most important aspect of the entire debate. Without incentive, why make a product? Without adequate R&D funding generated from drug sale profits, companies will be unable to develop newer and better drugs. However, how do we ensure that the profits are not beyond reasonable? The answer is: We can't, only competition can. As such, the ideal way to tamp down prices would be to encourage competition through true free-market principles. Unfortunately, this probably won't happen so long as other countries, large insurers and the U.S. government continue to negotiate prices with Big Pharma.

With no real prospect for real reform, it seems there are four reasonable options available to attempt to bring prices down. The first is for individuals and small groups to unite and negotiate side deals of their own with the pharmaceutical companies to try to solve their acute drug cost problem. The second would be to encourage competition by limiting patent exclusivity, though not to such an extent as to adversely affect product return-on-investment for the drug companies. Third, and following from the second, with increased competition a concerted effort to make patients and doctors aware of cheaper alternatives to "first in the market" drugs combined with variable co-payments will reduce demand and foster competition. Fourth, and last, the viability of a plan to turn the NIH into a drug developer within a competitive environment, and not just a research funding device, should be investigated.

Obviously, there are other ideas out there that I have not touched on. My goal in writing these posts was to clear up in my own head what the "Big Pharma" debate was about. The fundamental point I have taken away from my research is that the average citizens of the United States are not operating on a level playing field with the rest of the world. Unfortunately for us, the rest of the world isn't going to suddenly decide to pay higher prices, and thus share the burden of R&D, on their own. Given this, all we can really attempt to do is implement small reforms, some of which I have outlined above. Hopefully, these can lessen our burden as we await market forces to impact the rest of the world and tilt the playing field back to equilibrium. Absent that, we are left to accept that so long as we are the world's dominant power we will be held to a higher standard...and higher prices.

(1) J.L. Wagner and E. McCarthy, “International Differences in Drug Prices,” Annu Rev Public Health. 2004;25:475-95.
(2) I Senior, “Is parallel trade in medicines compatible with the single European market?,” Pharmacoeconomics. 1992;1(Suppl 1):70-6.
(3) P.M. Danzon, “The economics of parallel trade ,” Pharmacoeconomics. 1998 Jul;14(1):135-7.
(4) G. Emilien, “Future European health care: cost containment, health care reform and scientific progress in drug research,” Int J Health Plann Manage. 1997 Apr-Jun;12(2):81-101.
(5) S.M. Ess, S. Scheeweiss, and T.D. Szucs, “European healthcare policies for controlling drug expenditure,” Pharmacoeconomics. 2003;21(2):89-103.
(6) N. Pavenik, “Do pharmaceutical prices respond to potential patient out-of-pocket expenses?” Rand J Econ. 2002 Autumn;33(3):469-87.
(7) P. Stein and E. Valery, “Competition: an antidote to the high price of prescription drugs,” Health Aff (Millwood). 2004 Jul-Aug;23(4):151-8.
(8) D. Baker, “A free market solution for prescription drug crises,” Int J Health Serv. 2004;34(3):517-26.