Limiting Drug Prices Means Limiting Future Cures

Should the United States control drug prices? Every other advanced nation does, and more than a few Americans think we should too. The advocates say U.S. medication costs are skyrocketing and wonder why they should pay more than consumers in other parts of the world. They complain that drug consumption is manipulated through advertising and marketing. And they blithely dismiss the idea that lower prices might damage essential research and development.

But their arguments don't hold up. For one thing, drug costs have been slowing relative to the rest of the healthcare system. After adjusting for inflation, data from the Centers for Medicare and Medicaid Services show that the growth rate for prescription drug spending dropped from 9.3% in 2006 to 0.8% in 2007 and 3.4% in 2008. Pharmaceuticals' share of health spending has slowly declined from 10.2% in 2006 to a predicted 9.8% in 2009.

A big reason for the U.S. decline is that we are in the middle of an unprecedented surge in blockbuster patent expirations, and when patents end, generics enter. Generics now account for more than 60% of all prescriptions (more than 70% in the Medicare Part D drug benefit).

If healthcare reform, with all its virtues, should turn to drug-price controls, we will be stacking the deck against dramatic improvements in our future health.

The argument that drug marketing, especially direct-to-consumer advertising, inflates the amount Americans spend on drugs is also specious. With spending on consumer advertising equal to less than 2% of drug sales, according to TNS Media Intelligence, advertising is a weak force in the pharmaceutical market. Numerous economic studies of consumer advertising have failed to demonstrate a noticeable impact in any drug market. Promotions aimed at doctors are a bit more effective, but again, research has not revealed a large effect on prescribing.

Drug prices are an easy target for regulation because if you look only at the costs of manufacturing and distribution, the profit on an individual pill can appear huge. But that is because we are talking about an industry in which most costs are borne upfront for development. Price controllers abroad know that even when prices are cut to half the market level, the typical drug will still be supplied because manufacturers will still make a profit.

But we have to also understand that price controls disincentivize research. Most new drug development projects end up as costly failures. In fact, the biotechnology industry, the source of dozens of lifesaving drugs, has yet to make an industrywide profit. What motivates continued research, whether in biotechnology or traditional biochemistry, is the expectation of high profits on rare successes.

Price regulators in European nations actually understand the logic of profits and innovation, but they also know that their own nation's share of worldwide profits is so small (just a few percentage points) that their prices have a negligible effect on research-and-development incentives. We are different. The U.S. accounts for perhaps 40% to 50% of worldwide profits. We cannot ignore the impact of price controls on innovation.

Pharmaceutical innovation is widely misunderstood. What's important isn't simply how many new drugs are approved by the FDA each year. We need to look at the fruits of all ongoing research, much of it devoted to exploring the benefits of older drugs.

Consider the history of the statin class of cholesterol-reducing drugs, such as Zocor, Pravachol, Lipitor, Crestor and others. Clinical trials on these drugs have revolutionized scientific understanding and medical treatments for heart attacks, yet most of that research was performed by drug manufacturers long after their drugs had been approved. Drug manufacturers need to have an incentive to continue researching both new drugs and those they have already brought to market.

We are still early in the learning curve for harnessing biotechnology and the rest of modern biology and chemistry, and even computer science, to the task of improving health and letting us live longer and more active lives. Only after two decades or so of difficult research did private industry create a biotech drug to attack cancer cells by limiting their blood supply. Now dozens of drugs based on the same idea are in development, with much promise for cancer patients.

Or consider research on therapeutic vaccines. These are designed to buttress the immune system to attack an illness rather than prevent it, as traditional vaccines do. After many false--and expensive--starts, a therapeutic vaccine for prostate cancer is close to FDA approval. Other therapeutic vaccines are in development for cancer, Alzheimer's disease and AIDS. In the meantime, the first form of gene therapy, in which a drug actually alters the patient's DNA to prevent or cure a genetic disease, has been approved. Again, this small triumph (for a very rare disease) arrived after decades of failure, and again, no one knows what larger victories may lie ahead.

Of course, the list of breakthroughs yet to be achieved is long, and it is by no means restricted to exotic forms of biotechnology. We need to make sure nothing gets in the way. The surest way to discourage high-risk, high-payoff drug research is to raise the specter of capping prices after victory has been achieved.

If healthcare reform, with all its virtues, should turn to drug-price controls, we will be stacking the deck against dramatic improvements in our future health. We should not control our drug prices. Instead, the rest of the world should stop controlling theirs.

John E. Calfee is a resident scholar at AEI.

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About the Author


John E.
  • Economist John E. Calfee (1941-2011) studied the pharmaceutical industry and the Food and Drug Administration (FDA), along with the economics of tobacco, tort liability, and patents. He previously worked at the Federal Trade Commission's Bureau of Economics. He had also taught marketing and consumer behavior at the business schools of the University of Maryland at College Park and Boston University. While Mr. Calfee's writings are mostly on pharmaceutical markets and FDA regulation, his academic articles and opinion pieces covered a variety of topics, from patent law and tort liability to advertising and consumer information. His books include Prices, Markets, and the Pharmaceutical Revolution (AEI Press, 2000) and Biotechnology and the Patent System (AEI Press, 2007). Mr. Calfee wrote regularly for AEI's Health Policy Outlook series. He testified before Congress and federal agencies on various topics, including alcohol advertising; biodefense vaccine research; international drug prices; and FDA oversight of drug safety.

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