Deregulation and Market Forces Can Lower Pharmaceutical Prices

The pharmaceutical market is anything but free at present.


In the rollout of their "Better Deal" program this week, Democrats identified high prescription drug prices as a major challenge facing America and proposed new regulations to rein them in.

Their diagnosis is spot on, but their prescription is backwards. The way to roll back pharmaceutical prices is to deregulate and rely on market forces. But for that to happen, both Democrats and Republicans will have to resist the pharmaceutical lobby, which benefits from the status quo and is very generous with its donations.

In 2015, spending on prescription drugs totaled $325 billion, or roughly $1,000 for every person in the U.S. according to federal data. Pharmaceutical spending rose by 9 percent from 2014 to 2015, far outstripping the growth of the GDP.

Drugs in the U.S. often cost more than twice as much as they do in other developed countries. A 28-day supply of Humira costs a whopping $2669 on average here, according to the International Federation of Health Plans. The same supply costs $822 in Switzerland, $1253 in Spain, and $1362 in the United Kingdom.

In a free market, such price differences are normally arbitraged, but the pharmaceutical market is anything but free. Federal law generally prohibits drug importation, so there is no legal way to ameliorate the international price gap. The pharmaceutical lobby (no surprise) opposes congressional efforts to legalize drug importation.

Drug companies argue high prices offset the high costs of developing new drugs. A 2014 Tuft's study estimated the average cost to bring a new drug to market at $2.6 billion, much of it devoted to complying with the FDA's labyrinthine clinical trial process. Since 1962, when Congress empowered the agency to evaluate efficacy as well as safety, the FDA's trial regime has steadily become more onerous.

The Bush Administration and Congress accelerated pharmaceutical price inflation by adding prescription drug coverage to Medicare in 2003. Legislation that added the costly new benefit included a "noninterference clause" that banned Medicare from negotiating prices with pharmaceutical companies.

This places the government at a serious disadvantage with foreign governments that negotiate, putting a lid on their expenditures. Empowering the government to do anything is frightening for free market advocates, but consider this: when drug companies are selling to Medicare beneficiaries, they are essentially acting in the role of government contractors. It is in the taxpayers' best interest to allow the government to secure lower prices for the goods and services it purchases.

In a normal market, consumers can act to limit prices by foregoing consumption or choosing less costly substitutes (like generic drugs or over-the-counter medicines). But since most prescription drug costs are covered either by the government or private insurance companies, consumers don't have much of an incentive to exercise these options.

In this system of third party payment, drug consumers are insulated from the true cost of the pharmaceuticals they buy and those costs supported by taxpayers. This cost shifting can be reduced by increasing drug copayments and making them a percentage of a drug's retail price.

Another way to lower drug costs is to increase competition. Right now, pharmaceutical companies are shielded from competition by patents and exclusivity periods. Even when drugs lose FDA monopoly protection, the FDA continues to effectively limit competition by delaying approval for generic alternatives, as Reason's Ronald Bailey recently reported.

Patents are normally defended as a necessary incentive for drug price innovation, but if FDA approval costs were lower, this incentive could be reduced – by, for example, shortening the life of pharmaceutical patents.

Further, many pharmaceutical patents are dubious at best, conferring monopoly privileges to "me too" products that aren't legitimate innovations. AstraZeneca's patent for Nexium is a classic example of this abuse.

After making a fortune on its initial acid reflux drug, Prilosec, in the 1990s AstraZeneca reacted to its patent expiration in 2001 by patenting a slightly modified molecule with the same active ingredient in Prilosec. The marginally better Nexium generated $6 billion of revenue, selling for more than ten times the price of off-patent Prilosec.

Patients might have bought the cheaper Prilosec, but AstraZeneca got approval to sell it over-the-counter, in many instances making it ineligible for insurance coverage. Patients paid the same or less for prescription Nexium; with taxpayers and insurers made up the difference. With insurance, there was no incentive to buy the cheaper alternative while physicians, who in the current system receive all sorts of perks from pharmaceutical companies, had no incentive to suggest the over-the-counter option.

This raises the question of why so many drugs are sold by prescription in the first place. Prescription drugs must be dispensed by a pharmacist. Eliminating this generously compensated middleman would reduce their cost. Prescriptions might enhance safety, but that can't possibly explain Nexium and Prilosec. Indeed, many dangerous products – like hydrochloric acid – are sold without a prescription.

Reining in drug prices as Democrats are suggesting would not only benefit consumers who lack adequate drug coverage, but it would reduce government spending by tens of billions of dollars a year.

We can get these benefits without adding new layers of regulation. Instead, let's expose drug companies to the pressures of a truly competitive marketplace.

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  2. Get government out of the medical industry.

  3. Deregulate and they’ll charge a million bucks a pill. No one will be able to afford medicine and everyone will die. Duh.

    1. To be fair, as European examples show, single payer systems and regulated healthcare can deliver much lower medical costs than the US public health care system.

      What Democrats and progressives offer is a hugely overpriced crony capitalist system, while lying and pretending that they would regulate it as well as the European systems are.

  4. Must be fake news; everybody knows government regulation is required for proper health care.
    Just look at Charlie Gard.
    Look at the vast difference in regulated surgery .vs Lasik or cosmetic surgeries. Which one has had reduced costs and improved outcomes?
    Next thing we know some fool will pretend individuals should have some kind of choice in what is on their own insurance plan!

  5. The Prilosec/Nexium tale is infuriating. It’s almost like the drug companies, the doctors, and the bureaucrats deliberately obfuscate everthing for… some reason, I can’t imagine what it is.

    1. Yeah, it looks to me like the FDA is thoroughly in the pocket of the big pharmaceutical companies. The direct-to-consumer genetic testing market is the same thing. Keeping consumers from knowing about their risk factors unless they get the information through traditional medical channels – so that companies can keep profiting from the tests long after the patent has expired, and charge insane prices for it. Nevermind that the patients insurance company isn’t going to pay for it unless there is a medical necessity, so in most cases, getting such testing done through the FDA approved channel is out of reach for most consumers. And getting testing done is not even a safety risk, the FDA’s excuse that consumers will misuse the information is just blatantly contrived – an excuse to maintain the monopoly of the established player.

      1. Regulatory Capture ain’t just a river in Egypt.

      2. That’s all a fx of “intended use” of products. You advertise it a certain way, that’s its intended use. Congress made it hard for products to be marketed legally for medical uses as intended by consumers. It’s not FDA’s excuse, it’s Congress’s.

    2. Yes, but who’s to blame? Congress, really.

      Is it a problem that Prilosec is OTC? It’s only a problem in the sense of the incentive provided by insurance to buy Nexium. That’s a problem because of the layers of subsidy for insurance, or “subsidy” relative to after-tax benefits. Congress’s fault.

      Is it a problem that Nexium is not OTC? If nobody sponsors an application to have FDA license it for nonprescription sale, FDA is not going to make such a rule on its own. Anybody can sponsor such an application (doesn’t have to be the marketer), but the research & document’n required would be very costly. FDA’s interpret’n of the FFDCA could make such appl’ns cheaper, maybe by a factor of 2 or 3, but ultimately it’s Congress’s fault for putting on such requirements.

      The bureaucrats are doing the job Congress laid out for them. The drug cos. are selling their products. The doctors are doing their job too. The insurers as well. But it’s Congress that laid out the playing field & made the rules. The game can’t be played that way much better than it already is.

  6. One of the proposals that has been kicked around recently is to introduce “reciprocity” in drug approvals between the EU, US, and Canada. So if a drug passes approval under their system, it would be legal to sell in the US, and vice versa. Drugs would only have to go through on set of approval processes, Americans could get access to drugs currently only available in Europe. This could be introduced along with a treaty to make approval standards more uniform among the three regions so that concerns about standards being much lower elsewhere could be allayed.

    The objective should really be to make sure that there are more competing drugs on the market, and that patents and exclusivity periods are allowed to expire so that generics can enter the market. Right now, the FDA approval process and the patents and exclusivity periods described present a significant barrier to monopoly power in the market from ever expiring. Whether you agree with IP rights or not, everyone should agree that it shouldn’t last *forever*. When the patent expires, people should be free to use generic versions. The way the FDA keeps generics off the market is a classic example of rent-seeking behavior and regulatory capture.

    1. Neverthless, it’s an at least arguably correct interpret’n of what Congress meant by “new drug” that Congress has since ratified by their amendments regarding generics and ANDAs.

  7. And not one mention of the price controls imposed by our european and canadian betters. Instead we just get the same Democratic retread about medicare negotiating on drug prices.

    1. Yes, I’m disappointed Marc didn’t point out that if arbitrage existed to equalize these prices, it would vitiate the arrangements w foreign countries, & provide an incentive for drug makers not to market their product overseas at all.

  8. No discussion of other countries that don’t respect patents for the drugs that are being invented and developed in the US? Not that this explains the entire difference in pricing, but a big reason for the difference is that other countries severely limit protection for patents on drugs from US. That’s a big part of why they are cheaper in foreign countries. They allow generics to be made/sold for patented drugs. Pharma companies are forced to sell their product cheaper there to avoid being entirely replaced by generics.

    Why are drug prices higher in the US? Because we are a rich country and are essentially paying to subsidize drug invention/development/testing/availability for the rest of the world. If other countries respected the patents, they would pay prices that are higher and US prices would be lower.

    1. Why are drug prices higher in the US? Because we are a rich country and are essentially paying to subsidize drug invention/development/testing/availability for the rest of the world. If other countries respected the patents, they would pay prices that are higher and US prices would be lower.

      That is just complete bullshit. eg Insulin. Discovered/isolated nearly 100 years ago. Pretty much all original research on insulin was completed/understood by the early 1960’s. Even the synthesizing/purification research was done by the late 1970’s. It is WAY beyond any conceivable need for patent. It costs $2-3 in the Third World (where there is competition) and $60 in the US (where there is no competition because we are still dicking around with patents). The US is not ‘subsidizing’ anybody.

      1. But, JFree, if you have the power to read minds- as I assume you must, given your blithe assertion that Curt was referring to Insulin and not one of the thousands of other drugs developed in the US over the last 30 or so years- why are we even having this debate? Just read the minds of all the people developing drugs throughout the world, and post their ideas in your next comment for everyone to use for free! I’m so glad you informed all of us of your abilities.

        1. not one of the thousands of other drugs developed in the US over the last 30 or so years

          Over that time, there have been about 200 new active chemical entities discovered per decade worldwide. Many of which arise from academia (govt grants) or small biotech (which admittedly has ‘innovated’ a way of capitalizing discoveries/patents – which has nothing to do with actually developing/producing drugs). That 200/decade is a reduction of 50% from the 1970/1980’s and 75% from the 1950’s/1960’s. That reduction in actual innovative discovery is a direct consequence of the US/UK patent model being imposed on the rest of the world via ‘free trade’ agreements and the merger/consolidation of the industry globally via the almighty reserve dollar. Both of those two are related – but the consequence is REDUCED innovation/research.

          ALL of the rest of the difference between pharma patents granted and that 200 is nothing but reformulations of existing pharmas in order to extend patent protection – in order to keep drug prices HIGHER than they would otherwise be with actual competition and a free market. And reformulations jack up the price of FDA process because they are NOT innovative so it is more expensive to FIND new efficacies that are ‘worthy’ of extensions of monopoly protection.

          1. I don’t think anyone here is arguing that FDA regulatory-capture-by-patent-protectionism isn’t a problem. Indeed, it is THE problem.

            The point is that regardless of whether there are actually thousands of new drugs (a number I threw out blindly) or merely hundreds of them (as you assert), America represents 30% of the global medicinal market, and 50% of all new meds developed, vs. 70% and 50% for the rest. That sounds like a 2x as fast dev cycle to me.

            And something tells me that reformulation and the other various patent trickeries are not unheard of in Europe either.

            1. 50% of all new meds developed

              and that is precisely the ‘innovation’ pond that has been shrinking. By faster than our relative size within the pond has increased.

              something tells me that reformulation and the other various patent trickeries are not unheard of in Europe either.

              We forced our system on Germany in the 70’s. The others around then. So yeah – I’m sure they are now learning how to play the games we told them to play. Interestingly however, they mostly play that game in the US market – so that Americans not Europeans pay the cost of that BS.

              The only major holdouts from our system are Brazil/India/China. And they ain’t gonna change – because manufacturing/production is always gonna be their advantage and because they have no intention of just handing over their biodiversity and indigenous knowledge to multinational biopirates/bioprospectors.

              1. No reply to my second reply? Not implying it was deliberate, just wondering if you have an answer to it. Eg: are there other reasons the pond might be shrinking?

                Nonetheless, if our “relative size” in the “pond” is, in fact, increasing, or is stable at a higher level than Europe, then that is still an indictment of the European Model (eg “negotiation” via single-payer monopsony resulting in bureaucratic price-fixing), is it not? Which in turn would imply they *are* somewhat dependent on the USA.

                Regardless, I think we can both agree that the FDA’s status as Sword and Shield of the Pharma (TM) is the real problem in our system, yes?

                1. are there other reasons the pond might be shrinking?

                  Perhaps. But it is truth that our patent model deters innovation long-term where a process patent system doesn’t (and actually tends to produce periodic bursts of innovation). You can see it in the comparative histories of the chemical industry up to roughly WW1.

                  an indictment of the European Model (eg “negotiation” via single-payer monopsony resulting in bureaucratic price-fixing)

                  Not sure how that relates to patents. But purely economics – granting a monopoly on one side and monopsony on the other obviously affects a market structure. Maybe that is the best way of resolving a situation where the monopoly has to be granted but where you want to recapture the rent. Or not. idk as a general rule and not enough info to analyze the specifics.

                  1. It relates to patents in the sense that our patent system *might* not be all bad, if we produce more new drugs faster than the EU’s patent-evasion does. The whole point of Europe’s price negotiation is to negate monopolist patents; the problem is that ends up putting a bureaucrat in charge of pharma investment.

                    Anyway, if you have to have a monopoly, I think it is fairly obvious you would need a monopsony to counter it- that is, indeed, a major, if not exclusive, reason Europe’s drugs are so much cheaper: the EU and the USA both allow patent monopolies, but the EU counters with price-fixing via monopsony. The key being that if the USA could reduce those monopolies- by allowing generics, and not allowing reformulation trickery- we could have the best of both worlds: market innovation driven by profitable patents, AND low prices from adequate competition.

          2. Also, reductions in rate of chemical entities being discovered… Correlation equals causation? Just because the rate went down as the “Evil Anglo-Saxon Patent System” came in, that does not auomatically equal a cause-and-effect relationship. What other events occured during that time? It seems akin to blaming Apple and Google when Moore’s Law inevitably begins to run dry. Rapid innovation only lasts as long as there is still “low-hanging fruit” to discover, after which the law of diminishing returns sets in.

            As it happens, I’m not really a fan of patents/IP as a concept, so this is all very interesting, though I remain skeptical.

  9. Requiring a prescription also forces you to go to the doctor. So, don’t expect the AMA to advocate making more drugs OTC.

    1. Sis back in the states from living in Japan for a few years. no Insurance, throwing up for 10 hours on Christmas Eve. Damn, I sure wish we could buy strong OTC anti nausia meds.. nope. no doctors open, have to go to the ER.

      Us: Hey, we need some nausia meds, she has a stomach bug, no insurance, we just need some nausia meds.
      Hospital: Oh right this way: Is she pregnant? No, ok, well here let’s do all these tests, hook her up to machines..
      Us: but she just needs some nausia meds, and she has no $.
      Hos: That’s alright, you can just apply for indigent care.
      Us: so there is no way you can just give her a shot?

      6 hours later:

      Hospital: well it looks like she just has a stomach virus, here a shot for nausia, drink fluids, bla bla bla.. oh BTW, we listed/charged her for condition 4 (most life threatning classification determined by multiple organ failures and emminent death. Oh and on top of the testing, here is a bill of $500 for a pregnancy test..
      Us: What the hell, we said she wasn’t pregnant!
      Hospital: Well some people lie, (and we have to know if she is pregnant because none of the treatments we gave her would affect a pregnancy in any way, and sure you could have paid $10 for an OTC test, but where is the markup in that?
      Us: this bill is crazy, what is Level 4?
      Hospital: Oh well it would have been $$$$$ if you were using insurance, so we gave you a discount.. wait, you were working to pay off the student loans? well guess you don’t qualify for indigent care, bye now.

      1. 100’s of hours of study, phone calls, letters, and 9 months later:

        Us: You’re up-coding the level on your patients above the guidelines listed in the AMA section bla, paragraph bla, subsection bla, and charging the insurance these higher levels, that is fraud! at most she is a code 2! There is no way she is paying this.
        Hospital: Well, we are not admitting to any wrong doing, so we will not be changing the fradulent coding, but we will give you a one time good will discount. Now go away and stop wasting our time.

        Us: Damn I wish I didn’t need our great lord govertment’s permision to buy some damn medicine.

  10. many pharmaceutical patents are dubious at best

    ALL pharmaceutical patents are dubious and counterproductive. We should not be granting monopoly over discovery of a chemical – only over the invention of a process to synthesize its production. A chemical is a product of nature not a human innovation. Granting monopoly over nature serves only to reinforce rent-seeking. Granting monopoly over an innovation serves to hasten investment and research.

    The German/Swiss/French (pre-WW2) model worked. They granted only process patents – not end-product patents. The US/UK chemical/drug industries of the time (granting product patents) were irrelevant (glorified pharmacies) – until they stole the German patents/companies in WW1.

    ‘Research’ in the US/UK pharmaceutical industry was founded on an emulation of the German model. Penicillin was fortunately NOT patented by Fleming. Instead, when WW2 started, it was recognized that it has no value unless it can be produced on a huge scale. Discovery of those methods is what the patents were awarded on. Those processes enabled the ramp up from two doses (in March 1942) to a (potential) 646 BILLION doses (by 1947). The research into what else could be synthesized that way resulted in the discovery of every other class of antibiotic in existence over the next decade. But since the latter discoveries WERE patented under the US/UK ‘product’ system, the result was gradual elimination of all antibiotics research.

    1. “a product of nature not human innovation”

      Which human innovation discovered… Just like all other products. By this logic all information is “nature” and thus should be free of IP- which is, incidentally, a perfectly acceptable view, but a great bit bigger than mere pharmaceuticals.

      And the “process” of making them is a product of nature too. After all, are not all medicinal manufacturing machines and devices comprised of atoms bonded in a given pattern? What *philosophical* difference is there between a pill, and the machine that makes the pills? Both are made of natural materials (eg mass-energy et al) in a natural pattern, yes?

      1. Which human innovation discovered…And the “process” of making them is a product of nature too.

        Penicillin is a good example of the difference here. Molds/fungi/soil have been used medicinally since forever. Fleming isolation and discovery of what is happening and how it works is patentable in our system. Which means he could have patented and then turned around and charged folk healers royalties or taken them to court or prevented anyone else from using penicillium for anything. Or extended the patent near forever by discovering application X then Y then Z then etc. IOW – the govt grant of monopoly will only benefit anyone xFleming coincidentally if that is what Fleming wants to do.

        A patent for a synthesized process is different. Can’t use it to stop mold from producing penicillin by its own process. Can’t charge folk healers royalties. Can’t stop others from inventing their own methods of synthesizing penicillin. The patent has no intrinsic value – unless he uses it to capitalize and scale up or license others to do that. And chemical processing leads to a ton of later experimentation with feedstocks and byproducts and process changes. Which is a serendipity effect of a process patent (since those products can’t be patented either) but can be huge. All (or almost all) classes of antibiotics are a result of those experiments in originally producing penicillin by fermentation.

        1. If penicillin has already been in use for centuries, then it should be labeled “off-patent” right from the start. New processes should obviously be treated differently, as you say.

          I do see what you’re saying about patenting “activity” instead of “information”… But there is still an argument for the latter: after all, not ALL fungi and molds are easily discovered, and their properties may not be found even if the organisms are commonly known. Allowing patents incentivizes the market to go out and find those properties, either by vigorously re-examining existing compounds, or going out to the Andes or Darkest Africa or Borneo and looking for tree frogs and snails and algae and whatever else might have medicinal properties yet undiscovered. The key is to not let them hold those monopolies too long.

  11. I agree that a lot more Rx should be OTC, and that pharmacists are mostly overrated Rx managers, and could be replaced with a more generic manager for the most part. I am on Medicaid now, and pretty much only the cheap generics are automatically dispensed, with the expensive name-brands requiring prescriber paperwork. I was on a ObamaRomneyHeritageCare plan that was “cost-conscious”, and the difference was a much larger co-pay for name-brand. It’s certainly enough of an incentive to waste $ on the name-bran when the generic will do fine.

  12. Government and government agencies are again out to protect consumers…from lower prices!

  13. Patients might have bought the cheaper Prilosec, but AstraZeneca got approval to sell it over-the-counter, in many instances making it ineligible for insurance coverage. Patients paid the same or less for prescription Nexium; with taxpayers and insurers made up the difference.

    You know how European health care systems deal with this?

    “Prilosec is adequate. Furthermore, you can pay for it yourself. If you want Nexium, we won’t reimburse it.”

    Generally, if there is an adequate and cheap OTC drug, that’s what you get in Europe.

  14. Deregulation, lower taxes, still lower taxes has done wonders for Kansas.

    So much so that Brownback has bailed to do that spreading Jesus thing. A job he voted to create when he was in Congress in 1998.

    Damn, that trickle down just never seems to do anything but piss on itself till it goes dry.

    No article on that fiasco, eh

    1. If the market decides that agriculture and manufacturing (which I’m assuming are the main industries in Kansas) don’t need as many employees anymore thanks to automation and foreign competition, nothing the government does will matter.

      Raise taxes to 95% or lower them to 5%… the jobs are gone.

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