The False Promise of Pharmaceutical Price Controls
The Biden administration has proposed to fix the high cost of pharmaceutical drugs with a worn-out policy: Price controls. Of course, they will never call it “price control” because failed attempts litter history, including gasoline in the 1970s. Instead, through Executive Orders and the failed Build Back Better Bill, the Biden administration attempts to implement drug price controls via euphemisms, such as imposing a “maximum fair price” and requiring “government negotiated pricing.” While the objective of lower drug prices is widely agreeable, adopting price controls falls prey to the standard economic fallacy of focusing on short-term, static gains at the expense of long-term, dynamic incentives to innovate. What Americans need is a market-based solution—not a regulatory one.
While the price setting mechanism in the pharmaceutical industry is complex, it is helpful to consider drug pricing in two distinct stages. In the first stage, a drug receives a patent, which affords exclusive property rights to the patentee over the new drug formulation for a limited period. Patent rights balance the incentive to create (via the reward of exclusive property rights) with the social benefit of widely distributing the idea in society (via the limited period of exclusivity). In the second stage, a drug loses its patent protection, enters the public domain, and becomes off-patent. A comprehensive solution to high drug prices must address pricing in both stages.
In the first stage, as UCLA Professors Armen Alchian and William Allen explained in Universal Economics, there is a difference between the costs associated with drug discovery and the costs associated with drug manufacturing. The former costs can reach several billion dollars for a single drug and include all the expenses poured into prior failed attempts, conducting randomized control trials, ensuring the long-term safety of a drug, and seeking regulatory approval. The cost of manufacturing, however, can be less than a dollar a pill. Focusing on the cost of manufacturing while ignoring the enormous expenses and resources associated with the cost of discovery is, again, engaging in a static view of the drug market. Breakthrough innovations are significantly less likely without the reward of exclusive market returns. This central idea shapes our patent system. Indeed, the most important public policy goal in this first stage is to preserve the incentive to innovate and move our collective stock of knowledge forward.
To bring competitive prices for drugs in the first stage, our system should empower consumers with greater knowledge of treatment options, including all the relevant benefits and costs. For example, the government could encourage objective, third-party assessments of the various treatment options, including potential off-patent substitutes for newly patented drugs. Further, the government should fully enforce consumer protection laws, including full disclosure. Such actions provide increased market clarity as to whether a newly patented drug truly represents a treatment option worth the likely additional cost compared to a drug already on the market.
In the second stage, the lowest hanging fruit is to remove all regulatory frictions that hamper generic entry. While the Food & Drug Administration (FDA) has already implemented a series of reforms, all regulatory hurdles should be ruthlessly eliminated unless they pass a cost-benefit assessment. Economic research on generic entry consistently finds that consumers greatly benefit when there are multiple generic entrants.
As a society, we should also consider allowing consumers the ability to directly purchase drugs from pharmaceutical companies (or via a retailer such as a pharmacy)—just like consumers directly purchase automobiles, over the counter drugs, and household chemicals. Specifically, significantly more drugs should be available to consumers without a doctor’s prescription. This does not necessarily mean the elimination of prescriptions. Pharmaceutical companies would still have the option of requiring a prescription and consultation with a doctor or pharmacist. It means the elimination of a one-size-fits all regulatory prescription regime where doctors and insurance companies hold all the control. In studying this issue, University of Chicago economist Sam Peltzman concluded there are few health benefits to mandatory prescription regulation.
Why not let consumers decide, without mandating an imprimatur from a doctor and insurance company, which available treatment is best? This will induce greater price transparency and competition and allow drug manufacturers to compete on the merits. Additionally, such a reform incentivizes the development of private sector organizations that would publish expert guidance on treatment options. Arguably, moving away from our current compulsory prescription regulation will provide consumers more information about efficacy and possible side effects.
There is no doubt that Americans pay a lot for medicine. The solution is not more empty promises of price controls, but rather unleashing market forces through the protection of property rights and elimination of mandatory prescriptions for some classes of drugs. Further, the FDA should continue to streamline its regulations to ensure that generic entry occurs quickly and without regulatory hurdles. A reformed drug pricing regime would afford a larger, and much-deserved, role to consumers in shaping the cost of their treatment.
John Yun serves as Associate Professor of Law at George Mason University's Antonin Scalia Law School.
