There's an argument about pharmaceutical prices on parts of the center-left through right in America that goes roughly like this: It is true that high pharmaceutical prices provide both the capital and the incentive for innovation. However, Europe is free-riding on our pharmaceutical spending. Therefore (it usually continues), we must get tough with the pharmaceutical companies in order to force them to force Europe to pay their full share.
This is rife with economic error. It imagines that there is some basket of drug money that the pharmaceutical companies need to recoup--if we pay more, that allows them to charge Europe less.
I, however, assume that there is a demand side as well as a supply side to the equation. That is, the pharmaceutical companies are charging Europe about as much as they are able to for drugs; they are also charging about as much as they can charge us. If Europe raised the price that they were willing to pay for drugs, this would not lower the price they charged us--any more than Citibank lowers your interest rate here because they just had record profits in Canada. What we are losing through Europe's refusal to pay higher prices for drugs is not help covering the cost of the drugs that our buying funds; it is the never discovered drugs that a larger and more lucrative market would have supported.
The main constraint on prices in Europe is that the buyers have monopsony power. Changing what America pays will not alter the demand side of the equation. European governments might realizing that they have been free riding on our drug payments, and decide to raise the prices that they pay in order to support more R&D. But the political incentives all run the other way, and I see no evidence that the EU governments are excited about spurring private sector innovation by offering high profits on life-saving drugs. So the most probable outcome of introducing monopsony power here is that the market for drugs shrinks to the point where it will support few-to-no new drugs. This result will be sufficiently removed in time from the decision to monopsonize purchasing that the politicians will escape most of the responsibility. And even if the public realizes that it has forgone future discoveries for the sake of a few dollars now, and wants to undo this, the fact that everyone is monopsonizing will make it difficult to enact such a change: no one wants to be the patsy, even if they themselves are made better off by paying higher prices and getting new drugs in return. Witness the insistence on multilateral trade deals, even though all the evidence suggests that unilaterally lowering your trade barriers makes your nation unambiguously better off.
Derek Lowe, a toiler in the bowels of Big Pharma, has more thoughts on this.
Is it the Monopsony, or is it the threat that EU countries will steal Pharma's intellectual property if they don't keep prices low? Or is it both?
I think that's basically correct. I don't see why the United States can't lean on other countries to relax their price controls, though. We have a great deal of power. Why not use it to reduce this free riding?
Moreover, there is a tradeoff between cheap prices now and new drugs on the future, but it isn't clear that we have exactly hit the opitimum. I think that's one point Austin Goolsbee was trying to make.
My guess is that pharmaceutial companies get too much patent protection at present.
Is this analysis the same when there are multiple suppliers? You used credit cards as an example, so that probably answers the question.
Are there any other ways for Congress to act that would force other price-controlling nations to pony up? e.g. outlawing exported drugs, trade sanctions?
One other issue that is related to what Derek Lowe writes is that given the political incentives to control the price of drugs through non-market mechanisms, we won't even realize that the consequences are happening when they happen. What I mean is, say the US takes over all drug purchasing in this country, and drives the prices down to say, French levels. That means less money for R&D and so, fewer new drugs.
But it's impossible for policy makers or the public to know at any point whether the amount of new drugs coming out is optimal, near-optimal, very suboptimal, or just a little suboptimal, because there is no way to measure what the optimal level of R&D output is. Drug companies can figure out how much R&D input will maximize their profits, but that's different from figuring out whether a new antibiotic and a new chemo-mitigation drug is more optimal or less optimal for a society than three slightly weaker antibiotics and one anti-psychotic.
So, there will be some level of R&D, but there is no way for us to determine whether it is better than current levels of R&D. If we go to a non-market mechanism, there isn't even a way for us to measure afterwards whether R&D went down or not. This makes regulation very attractive for policy makers, since no one can then second-guess them. But, lower drug prices are what everyone sees. It's a policy with obvious successes, but very subtle and difficult-to-measure failures.
And isn't this precisely what the United States has already done in the flu vaccine market? Shouldn't that be our canary in the coal mine regarding these sorts of policies? Look at not only the shortages that have occurred, but the relative lack of innovation from companies in pursuing potential vaccines for avian flu.
Megan is probably entirely correct that if the U.S. also adopted a monopsony system, the supply of new drugs would shrink.
However, the economics in paragraphs two and three are not necessarily correct. Drug companies, like all other companies, need to earn a return on their investment that adequately compensates investors for the riskiness of the business. Since for most drugs actual production costs are negligible compared to the cost of the research that went into the product, if Europe did pay more it may very well mean that drug companies could charge U.S. consumers less and still maintain an appropriate level of return on investment. If Europeans only pay for actual production costs, Americans are stuck with having to pay for all of the research.
The sword of Damocles that non US govts hold over US drug companies' heads is not enforcing the patent on their inventions, the 'monopsony' created to deal with the patent dependent monopoly is a bit of an illusion. Since all the guys Ms. McCardle are Dems, they never seem to get it into their heads that if they think drug companies make too much money they can just get rid of patents or reduce the length of time the state enforced monopoly the patent creates runs for. Then there'd be no state purchasing authority for good progressives to work on and be the heroic working for the little guys guys that they are. I suppose there is also the sort of create a govt monopsony to deal with a govt created monopoly has a 'pay one set of guys to dig holes and pay another set to fill them' in sort of thing going on and it reminds them of the New Deal.
It would seem that if the govt really got serious about stuff like this, it might have better luck with foriegn govts about US intellectual property if it were as tough about them as they were about copyrights for Hollywood. But I guess it couldn't since Big Pharma is all about nasty greedheads while Hollywood is all about artists who just want a fair return on their artistically motivated output.
The drug companies have an incentive to keep you alive and buying. To the government, you're just an expense.
"But the political incentives all run the other way..."
Not all of them. Several European countries have their own major pharmaceutical companies: Glaxo, Sanofi-Aventis, Novartis, etc. Perhaps the prospect of reciprocity might be used to encourage European governments to pay a little more for the drugs produced by American countries.
A similar dynamic occurs in other parts of the world. For example, IIRC, India has been less niggardly than its fellow BRIC country Brazil in negotiating prices with foreign drug companies because India is trying to nurture its own drug industry, and will want its companies intellectual property respected.
That should have been "American companies", of course. Desculpe, as the Brazilians say to foreign drug companies.
If the rest of the first world paid what we do for drugs, I don't care whether we'd see lower prices or more investment in research. Either way, we benefit. I don't see that it's necessary for the US government to "get tough" with these foreign countries - just for the US government to stop helping the drug companies maintain their market differentiation by trying to prevent US consumers from buying drugs in other countries. That leaves it up to the drug companies to work out how to deal with these foreign monopsonies. E.g., they might ration the quantities sold under controlled prices, and let those countries try to stop the smuggling so their own people would get their drugs. We'd wind up with a lower overall price differential, and the foreign countries beginning to face the true cost of their socialized medicine.
Third world nations might deserve different treatment, e.g. lower prices and US enforcement against their drugs finding their way to US consumers. However, I wouldn't include Mexico in this favored group - with all the money sent back to Mexico by legal and illegal immigrants, the only reason Mexico could remain poor is if the government has been systematically looting the economy...
OTOH, I do want the US government to continue to get tough with any foreign country that violates patents.
The sword of Damocles that non US govts hold over US drug companies' heads is not enforcing the patent on their inventions, the 'monopsony' created to deal with the patent dependent monopoly is a bit of an illusion.
This is true for much of the world, but not for Europe. Of the top 10 pharma, only 6 are American, and there are many more 2nd and 3rd tier European pharmaceutical companies who would not like the US to retaliate by voiding their patent protections.
MarkD, was that a reference to "Thank You For Smoking"?
Nick Naylor, "It's not only our hope. It's in our best interest to keep Robin alive and smoking!"
Both this post and Derek's focus heavily on the fact that higher US drug prices lead to more drug R & D. Stated in such simple terms, this is true, but possibly misleading. We need to consider how many new drugs we get for each extra dollar we spend. We also need to consider what types of drugs we get.
Pharmaceutical companies have an incentive to produce the drugs they can sell. As luck would have it, they're now allowed to put ads for their drugs right on TV. Does the success of a marketing necessarily mean R & D dollars were spent in the right area? Restless leg syndrome seems to be getting a lot of attention as of late, maybe this is warranted, or maybe people tend to over by sleep medication.
Even if pharmaceutical companies are making the right research decisions, they certainly aren't the only source of drug research. The United States, thankfully, is chock full of top notch research universities. If a drug company posts in 50 billion dollars in sales, how much of this even goes into useful research. It looks like those TV ads don't come cheap
http://www.sciencedaily.com/releases/2008/01/080105140107.htm
What if the government negotiates lower drug prices, then pumps then pumps billions into publicly funded research? The NIH's budget is $28 billion dollars. Meanwhile the top 10 drug manufactures are posting $80 billion in annual profits
http://oversight.house.gov/documents/20060919115623-70677.pdf
I'm not saying pharmaceutical companies aren't giving us anything useful. I'm simply suggesting that paying high prices for drugs probably isn't the most effective way of supporting pharmaceutical research.
At the very least, if Europe starts paying more for American drug, doesn't that lower trade deficits, put more money in our pockets, etc.? Isn't that good in its own right?
The U.S. regulatory regime is a lot stricter than Europe's and I wonder if some price differential is also to be expected considering that the entry costs into the American market are much much higher... Indeed, I think the major role of pharmaceutical companies is not really research (though of course they have come up with quite a bit of valuable stuff ie hepatitis vaccines, etc.) but as essential middlemen who can translate basic research into clinical products that have made it through the regulatory maze. In fact, the >800 million cost in getting a drug to market makes it likely that there will always be only a few suppliers of pharm drugs to the american market considering the risks and capital needed...
Yeah, I'd think the elephant in the room would be the low-value drugs that have high profit margins, but which are popular with the public. Meanwhile, a friend in pharmacology assures me that things like antibiotics which would have huge public health benefits are being underfunded.
Shift more of the R&D expense to universities and the government, and perhaps that would change. Perhaps not, but I'd love to see your take on it.
EERac,
It's worth noting that a lot of the marketing budget of big pharma is used to support joint-venture drugs developed by small-cap drug companies, that don't have marketing and distribution resources.
It's also worth noting that Canada has a number of these small-cap pharma companies that generate their profits by selling into our market. That ought to give us some leverage in getting Canada to shell out more for drugs developed by American companies.
Rob hit the nail on the head; pharma negotiates with Europe under the implicit threat of expropriation (i.e., compulsory licensing) if negotiations fail. ("Nice business you got there. Shame if anything happened to it...")
That's no more a fair and free negotiation than if in the same position an American pharma company were, say, to point out that the Marines were conducting maneuvers just off that country's shore. In both cases it's the implicit threat of invoking state power to force a resolution in one's favor.
So the most probable outcome of introducing monopsony power here is that the market for drugs shrinks to the point where it will support few-to-no new drugs.
How does Megan know it would be "few-to-no" new drugs? If she said "fewer", I would understand. But nothing in her argument tells us anything about the scale of the decrease in new drugs. Megan seems to assume that the decrease in new drugs (upon the US adopting monopsony purchasing) would be great. But I would think it equally as likely that the decrease is small.
Moreover, this post doesn't struggle at all with the question of whether the higher prices we pay for all drugs are worth the expected increase in the amount of new drugs. What is the value of those new drugs? And how does that compare with the value of the increased prices we pay?
All in all, a pretty superficial post.
EERac:
Your plan is interesting, but will (IMHO) only result in cutting salaries from industry standards to academic ones. Productivity will follow.
For a much smarter take than mine on NIH funding, try this Derek Lowe post.
http://pipeline.corante.com/archives/2004/09/09/how_it_really_works.php
Here's a puzzle for you: The software business, like pharma, is dependent upon IP protection around the world. Yet vendors are generally able to charge higher prices abroad (esp. in Europe) than they do here.
The per-pill sales model also is perverse in that it encourages vendors to find palliative medicines that patients consume every day forever rather than complete cures.
That said, the only alternative I see is to shift to giant prizes. E.g., some national or better, international body could ante up 10 billion for a cure for this or that malady, with each successful inventor getting the prize (2 approaches are better than 1). The patent would then be free to license for all comers. The price per pill would be equivalent to today's generics on day 1. There would still be problems with waste, fraud, and imperfect solutions, but that's life.
Lowe's essay, linked to by Klug above, is an excellent answer to the following:
Really, what is the definition of "research" here?
I would support Justin's antibiotics point with Larry's prize suggestion.
For any number of reasons, antibiotic research is not highly funded in the pharmaceutical industry. If you want to be cynical, it's because infections aren't chronic and there's less money to be made per pill. I like the "last resort" theory, which is that the better your antibiotic, the less doctors will use it.
Crazy-stringent hygiene strategies are a much, much better way of dealing with hospital-borne infection (I submit) than more antibiotics research. Maybe I'm wrong, but the Dutch "search-and-destroy" technique with MRSA seems to have borne excellent results. In a perfect world, we'd have both.
Nevertheless, what would happen once your antibiotic was published and you got your prize? I suspect that between its low cost and high efficacy (of course), the pills would get cranked out worldwide and resistance would do its dirty work.
Just out of curiosity, does anyone know the extent to which European-owned pharmaceutical companies (1) do their R&D in the US, and (2) fund it with their revenues from the US market? I've seen their names on some pretty big buildings over here, even if they are incorporated elsewhere.
Write NIH / NSF grants such that all research is explicitly work-for-hire for the Feds so the resulting drugs may be licensed at will by Medicare / Medicaid authorities?
There is a way to get more new drugs and to make current drugs cheaper without starting trade wars with Europe. Make the regulatory burden for drugs easier. This would involve treating drug consumers like adults thought, so it will never happen.
The per-pill sales model also is perverse in that it encourages vendors to find palliative medicines that patients consume every day forever rather than complete cures.
This recurring canard annoys me a lot. It’s childish, because it presumes that researchers can perfectly well find whatever they want, but choose to find palliative medicines instead of therapeutic ones. Having performed that research, I can assure you it’s not that easy. If it were, people like you could go into the lab, “cure” the disease, and put pharma out of business. So do it.
It also overlooks the obvious point that those accused of such cynicism will certainly need to avail themselves of medical care at some point in the future. In that respect this canard is much like the old feminist one that if only men got _________(fill in the blank) there would be a cure, as if the men (gasp!) involved in such research don’t have mothers, sisters, wives, and daughters. The notion is risible in its simplemindedness.
That said, the only alternative I see is to shift to giant prizes. E.g., some national or better, international body could ante up 10 billion for a cure for this or that malady, with each successful inventor getting the prize (2 approaches are better than 1).
Whoa. Where to start?
This idea, like the previous one, bespeaks a liberal arts graduate’s (or other layman’s) perspective on science. Simple: whoever shouts “Eureka!” first gets the prize, right? That’s the way Jeff Goldblum does it in movies, after all, and he’s typecast as a scientist (for some reason). Nothing to it.
In fact, scientific research generally progresses incrementally, not in dramatic lurches, and determining who was “the inventor” is difficult. (It’s hard enough now at the patent filing stage, when the whole project is a gleam in a researcher’s eye, and would be made even more so when $10 BN was at stake. Success would have a lot more than a thousand fathers then, I can assure you.)
Furthermore, inventing is a relatively small part of bringing a drug to market, and is considered as such in the industry. Most of the work (and expense) comes after the lead compound has been identified. (The FDA prefers that we not scrape something out of a flask and inject it into Granny to see whether or not it works, and whether or not it’s toxic). It’s only once a lead compound is identified that the cash bonfire begins, and a blizzard of pages fly off the calendar, as in the old movies.
To put the problem in perspective, who was responsible for building the Empire State building - the general contractor, the financier, the foremen of the work crews, the individual workers, who?
The patent would then be free to license for all comers. The price per pill would be equivalent to today's generics on day 1. There would still be problems with waste, fraud, and imperfect solutions, but that's life.
I’ll let Megan hold forth on the tragedy of the commons, but something that belongs to everyone belongs to no one.
So here we have a fine patent, available free to all comers (why bother to patent it, then?). Now all we need to do is get someone to risk $800 million to develop the compound, figure out its pharmalogical and toxicological properties, how to make and purify it, determine its stability and drug interactions, etc., and we’re all set (assuming the compound passes muster, which most don’t – Google “torcetrapib”). Whoever stumped up the $800 million can now start recouping his investment, right? Oh, wait - everyone can make the drug now that it’s approved, because it’s generic. So the first mover gets hammered for $800 million, but has the gratitude of the population for his contribution. People will be queueing up to be the first mover.
Again, to put the problem in mundane terms, would you build a house on land to which you did not have clear title? If not, why not?
Write NIH / NSF grants such that all research is explicitly work-for-hire for the Feds so the resulting drugs may be licensed at will by Medicare / Medicaid authorities?
We really need to do something about liberal arts education in this country. Outlawing it is beginning to sound like a good idea. /kidding (sort of)
This is a common misconception among non cognoscenti that NIH/NSF grants result in drugs. They do not (with rare exceptions). Non-clinical Federal grants typically support basic science that provide tools and targets for pharma, but not drugs per se.
There are several reasons for this. First, basic science is essentially scientific infrastructure, and the Government supports it for the same reason it builds highways: it’s not clear who would do it if the Government didn’t, as it’s another tragedy of the commons situation. The data generated help applied researchers in industry in their quest for new drugs, but only peripherally.
Second, the Government supports it to help train researchers for industry, and to support universities. Most major universities receive a substantial fraction of their operating expenses from Federal grants for research.
Third, research in medicinal chemistry generally is not suitable training for graduate students, especially past the early lead compound stage. There’s an awful lot of plug-n-chug grunt work that has to be done, but doesn’t teach anything. Grinding out a thousand closely related derivatives, peforming hundreds of thousands of repetitive assays, and performing necropsies on untold numbers of rodents, are not appropriate for graduate students.
Having grad students do this work is kind of like having researchers in metallurgy produce new hammers. It’s inefficient, it’s lousy training, and it doesn’t play to their skills in any case.
University research is so early stage as to be virtually worthless to industry in most cases. (I know; as a former academic researcher who went into industry and among other things used to evaluate licensing proposals.) It’s why academic researchers are freely forthcoming with their data; it’s rare that their data are worth much.
Put it in the criminal justice context. We’re trying to catch the Unabomber, and some guy says he saw someone in the area wearing a hoodie. That’s university research; a hint, a possible lead, but hardly equivalent to frog-marching Ted Kaczynski into a police station.
Matt B,
If that were the case, then nearly no PI's would ever get NIH funding. The way that many (probably even most) academic biologists function is by asking the question, "How can I spin this story so that it can be published?" rather than, "Is what I have found/discovered true and useful?" A particularly famous trick is saying things like, "We saw a 100-fold increase in protein X" when the amount of protein X to begin with was so low as to be close to undetectable, so a 100-fold increase is true, but irrelevant.
Yes, basic research in this country is done with the help of the NIH funding. Derek Lowe described academic biology in the best light. But in reality, so much of that money is wasted in academia because there is little to no incentive to control costs of one's own research if you're a successful PI and can get NIH grants almost automatically and there is no incentive for your research to be either useful or actually true. In fact, the structure of academia makes the incentives run in the other direction. So, to say that NIH research funding is close to big pharma's expenditures on research is to not understand, really, how research in academia works.
Gene,
Thanks for a more temperate rebuttal than mine!
Occam's Beard is clearly someone who's done the same kind of work I do (and I assure you that he's not me). That said, his reply above could have come directly out of my cerebral cortex - it is, in my experience, a completely accurate picture of drug research. GeneV's comment is spot-on as well.
All good comments.
One (rarely mentioned) aspect is that the extremely large regulatory burden on drugs make the economics completely different from those of, say, computers.
Decrease the regulatory requirements (e.g. allow monitored sales of drugs still in the experimental stage), and you would increase the number of competitors in most classes of therapeutics, lowering the price.
The US should simply say that they are the largest buyer and should not have to pay more than the lowest price offered to any other first world buyer. If Canada pays X then we should pay no more than X.
Supply and demand seem to be working for everyone except us. Europe is paying as much as they have to because we pick up the slack. We pay as much as we do because our current administration is in the bag. Markets, supply, and demand have little to do with our current situation.
It definitely takes two to tango, but sellers do not have to offer bargain bin rates to Canada and Europe. Of course Canada and Europe will not voluntarily raise their payments. But they will in all probability pay more if that is their only option to secure the product.
In a properly functioning market the US should pay less and Canada more. There is no other way to look at it.
BTW, my company runs into this situtation all the time with buyers (major health care providers all) of our software. If we offer our services for less to anyone, we have to offer it for less to everyone, even if they have previously committed to a higher price. It's in the contract.
University research is so early stage as to be virtually worthless to industry in most cases.
This is preposterous. Worthless? You might claim, correctly, that is 'early stage', but essentially any new technology used in drug research and development, being cell imaging techniques, genomics, flow cytometry, you name it, was developed earlier at federally-funded research labs. I'm not talking of actual molecule-research leading to a new drug, for which there's also plenty of examples of federally-funded research contributions. I'm talking the essential tools that you use in pharmaceutical R&D.
There needs to be a good assessment on what would be the actual contribution of Universities and government institutions to the final product, but to claim the contribution is "worthless" is outright ridiculous.