The World is Dining Out on America's Drugs and We Are Picking Up The Tab
Recent debate concerning prescription drugs has focused on the fact that drug prices in Europe and Canada generally are a lot lower than in the United States.[1] This difference has led states to attempt to lower prescription drug costs through various types of price controls. While price controls might bring drug prices in Ohio more in line with Canada’s, in the long run Ohioans will be hurt as incentives to create new drugs are destroyed.
Governor Taft, for example, recently expressed interest in a multi-state compact that would negotiate with pharmaceutical companies for reduced prices using its bulk Medicaid purchasing power as leverage.[2] This “negotiated” price will act as a cap on prescription drug prices and is a poor solution to the perceived unfairness between drug prices in Ohio compared to other countries.
Critics are quite right that the current situation is unfair, but they miss the point as to why. Americans pay the market price for prescription drugs while Canada, Japan, and many European nations force drug companies to charge them less. They do this by enacting legislation that strictly limits drug prices to a level closer to their cost of production.
For the most part, the market price of prescription drugs is high because of the lack of competition created by patents. Few complaints are made about drugs that have generic equivalents. Patents exist, however, to encourage the production of new drugs by allowing manufacturers to recover the cost of researching and developing new drugs.
By forcing pharmaceutical companies to sell closer to marginal cost, “negotiated price reductions” effectively negate the incentives created by patents. Since the United States is such a large portion of the worldwide drug market, the effect of price caps in Canada and Europe have not had a very significant effect on drug research and development.
Essentially, the United States is subsidizing research and development for the rest of the world. If Ohio and other states follow the lead of Canada and Europe in saying that they are now going to leave it to others to cover these costs, however, soon no one will be left to pass the buck to.
If negotiated price reductions come to fruition, the short-term effects will be readily apparent. Ohioans will have cheaper prescription and “revenge” against drug companies.
After the initial reductions, however, the lower return on the drugs that make it to market will mean that drug companies can only afford to produce those drugs they are certain will cover their research and development costs. This means less research, less innovation and fewer drugs down the road. Ohio’s biotech industry, one of the state’s few growing economic sectors, would be adversely harmed.
It will be hard to know what will have been lost, as a drug that can help mankind in 20 years is hard to envision today. The benefits of drugs researched many years ago, however, are possible to quantify today. Columbia University economist Frank Lichtenberg found that an expenditure of $11,000 on general medical care extends a person’s life by an average of one year. Spending $1,345 on pharmaceutical research and development, however, achieves the same result.[3]
Furthermore, increased drug research has a proven link with reducing the need for hospital stays.[4] Savings in drug costs may be forfeited several times over in terms of increased hospital costs and lost pharmaceutical innovations.
The introduction of price controls on prescription drugs, either directly or through “negotiated price reductions,” is a bad idea. Ohio would be limiting innovation and stifling research in an industry that can have a tremendous positive influence on the quality of life. A price cap bill might make prescription drugs more affordable today, but it is the wrong medicine for Ohio’s long-term health.
Notes
[1] Armond Budish, “Foreign medications cheap but not without some risks,” Columbus Dispatch, 3 January 2003.
[2] Luke Shockman, “Taft weighs drug-buying coalition,” Toledo Blade, 26 February 2003.
[3] Frank Lichtenberg “Do (More and Better) Drugs Keep People Out of the Hospital?” American Economic Review 86 (May 1996): 384-88.
[4] Ibid.
Aengus Barry is a former Policy Analyst with The Buckeye Institute. This article originally appeared as The Buckeye Institute's May 2003 Perspective.
