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DBL%20Hendrix%20small.png College chemistry, 1983

Derek Lowe The 2002 Model

Dbl%20new%20portrait%20B%26W.png After 10 years of blogging. . .

Derek Lowe, an Arkansan by birth, got his BA from Hendrix College and his PhD in organic chemistry from Duke before spending time in Germany on a Humboldt Fellowship on his post-doc. He's worked for several major pharmaceutical companies since 1989 on drug discovery projects against schizophrenia, Alzheimer's, diabetes, osteoporosis and other diseases. To contact Derek email him directly: derekb.lowe@gmail.com Twitter: Dereklowe

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In the Pipeline

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January 28, 2008

Laissez-Faire?

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Posted by Derek

Reader B.C. noted this on Ezra Klein’s blog over at The American Prospect, talking about Mark Warner’s Senate candidacy in Virginia. He quotes Warner as saying:

” We need to rationalize drug costs. I won't stand up here and bash pharma. But it's not fair that Americans pay for research and development of the whole world, as other countries all have some pricing constraints."

And Klein then adds:

As readers of this site know, our decision to forgo national bargaining (or even Medicare bargaining) while every other country does use their size to drive down costs has led to a situation in which we pay far more so that Canadians and the French can pay far less. That's what Canadian Drug Reimportation is all about: Buying the same drugs we buy here, but at the prices negotiated by the Canadian government. It's galling, and I'm glad to hear Warner giving voice to it.

It is galling, I have to admit, and Warner’s correct that the US market must be paying for the majority of the R&D expenses of the pharmaceutical industry (since this is where the majority of the money is made, in most cases). My reply was, though, that I was worried that Klein (and Warner?) might think that the solution was to run US prices down to those of the other countries, presenting my industry quite a shortfall on its hands. Here's B.C.’s reply to that (this is him, not Ezra Klein or Mark Warner):

”I disagree with your conclusion. If you have three people bargaining to buy goods and one is willing to pay much more than the others without regard to what the other two will pay, you will sell to him at the higher price and sell excess supply to the others at the lower price, if you are so inclined.

But if all three bidders have the same market clout, then something will have to give. The market will probably reset pricing for all bidders. It might mean reductions in monies available for R&D, it might not. If the bidders are on a more or less even playing field, the market will determine that. I think that is what Klein is saying.

As things stand now, one of the buyers has given the drug companies have a massive put. That's not fair to the (involuntary) stakeholders of that buyer. If that put is removed, there is a much higher likelihood of a more equitable distribution of the burden of R&D. OTOH, as long as that put exists, there is zero likelihood that the current inequitable distribution will be corrected.”

My take on this is that health care spending is in a different category than many other things, for reasons both psychological and political. You’d expect some ordinary economic good to be divided up among three bidders in this way, but I wouldn’t expect medicine to be. It would be politically popular to see prescription drug prices go down here in the US, but it would be (almost certainly) politically impossible to see them go up by the the corresponding amount in Canada, France, Germany, etc.

Of course, I’ve made an assumption there, that the current revenues of the drug companies would remain roughly constant, and just be divided up in a different way. That's probably not how it would work. If you somehow put that idea to a vote across all the countries involved, I’m sure it wouldn’t pass. The majority of consumers, and probably the majority of politicians, would be glad to set the price of drugs by fiat, and that setting would be dialed down to “nice and cheap”. The time lag involved in drug discovery would let you do this and not notice many problems, at least on the pharmacy shelves, for several years.

And that’s the problem with setting prices that way: the temptation is for whoever is on the thick end of the whip – that is, whoever can determine prices by force of law – to set them and be damned. It’s not just drugs: I’m sure that people would, if they thought they could, vote themselves cheaper cars, not to mention the gasoline that runs them. But oil’s a commodity that trades freely, and there’s a constantly changing market price for it. A new medication, on the other hand, has just one supplier. There's just one neck presenting itself.

That turns negotiations between drug companies and governments into a rough business. Very quickly, things can come down to their ultimate positions: “We won’t let you sell in this country” versus “We won’t let you have this drug”. Note that both of these end up with the citizens involved being denied a chance at medical care. It’s as if rug-merchant transactions tended to escalate into threats to set the bazaar on fire.

Governments have another weapon when things get to that point: compulsory licensing. This has already come up with Brazil and Thailand, and will no doubt be threatened again in other places. And that brings me to my depressing point: this playing field will never be level.

Ideally, I would like to see drugs, and drug companies, compete strictly on price and on effectiveness. And I’d like to see that happen around the world, and let supply and demand sort things out. I think that prescription prices would go down a bit here, and up in many other countries. At the same time, generic drug prices would probably drop outside the US. But it won’t happen. The more I think about it, the more I fear that drugs and other health care will never trade on a free market. The temptations to do otherwise are just too great.

Comments (14) + TrackBacks (0) | Category: Business and Markets | Drug Prices


COMMENTS

1. The Pharmacoepidemiologist on January 28, 2008 12:06 PM writes...

Perhaps it's that old memory of mine, but didn't we see this exact phenomenon happen when Nixon was President and we had wage and price controls? One of the results of that mess was 5 years of stagflation.

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2. The Pharmacoepidemiologist on January 28, 2008 12:06 PM writes...

Perhaps it's that old memory of mine, but didn't we see this exact phenomenon happen when Nixon was President and we had wage and price controls? One of the results of that mess was 5 years of stagflation.

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3. The Pharmacoepidemiologist on January 28, 2008 12:06 PM writes...

Perhaps it's that old memory of mine, but didn't we see this exact phenomenon happen when Nixon was President and we had wage and price controls? One of the results of that mess was 5 years of stagflation.

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4. milkshake on January 28, 2008 1:14 PM writes...

Sure people would vote for cheaper drug prices now even if it meant fewer new drugs later (as the development becomes less profitable)
You can have look what happens with local taxes - no politician is going to get elected on a platform of raising local taxes. (The homeowners who have to pay 1.6 or even 2% of their real estate value per year know that they are paying way too much already). Too bad that locally funded public schools suffer the corresponding decay in quality.

You also have to see that the curent pharma business model is flawed: there are staggering amounts of wasted money because of management excesses. Since there is not much competitive pressure to keep the prices of new drugs low, the inefficiency gets counted into the final drug cost. The development and approval process is byzantine and FDA is also a big part of the problem.

I would not mind if large insurers would negotiate the drug prices - you may not like Walmart as a evil giant but it is one of the forces that keep the inflation low in US - it puts such a price squeeze on manufacturers that they have to become more efficient.

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5. sigma147 on January 28, 2008 1:41 PM writes...

Yes, but how does this play out with regard to pharmaceutical marketing deregulation?

http://medicine.plosjournals.org/perlserv/?request=get-document&doi=10.1371/journal.pmed.0050001&ct=1&SESSID=4243c3e0e6570f400d3770666a1d465f

Looks to me like the US market is paying to be sold pharmaceuticals on a 2:1 basis relative to the cost to develop the same. Bit of an inequity there, doncha think?

How does this equation work in Europe or Canada, I wonder?

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6. SRC on January 28, 2008 1:59 PM writes...

I share your desire for the future, Derek, but also your scepticism that'll it be gratified any time soon.

The problem is that Europe's propensity for socialist "solutions" - and American tolerance for them - means that Europe will get a free ride indefinitely. That's because the exploited consumers are Americans, whereas many of the drug companies are multinationals. If the drug companies were American, the U.S. could have a WTO squawk, and could start twisting arms on that basis (cf. agricultural imports).

But as it is, that would be difficult to do, and so we're stuck with the problem.

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7. John Thacker on January 28, 2008 2:33 PM writes...

Yes, but how does this play out with regard to pharmaceutical marketing deregulation?

Nearly irrelevant. Marketing is designed to increase profits; it's supposed to be a profitable business unit. That's why you see the greatest number of ads for "lifestyle" problems where treatment is optional, or where people don't know that there are treatment options or might not want to mention the problem or think that it's a standard part of getting older. No one advertises for AIDS drugs or chemotherapy (except as part of a "look at how noble our company is" PR). It's absurd to claim, straight up, that money going to marketing is somehow "taken" from R&D. Of course you can argue that the pharmaceuticals are making less profit than they would if they would advertise less.

A somewhat more sophisticated argument is that one that pharmaceutical drug advertising is some kind of tragedy of the commons where the companies are essentially spending money to grab bigger slices of the same pie. However, this contradicts the other common claim, made by milkshake about that "there is not much competitive pressure to keep the prices of new drugs low." If there's a bunch of me too drugs fighting with advertising over the same pie for some condition, then that means that there *is* competitive pressure.

The other complaint about advertising, and probably the strongest one in my mind, is that it's an attempt to build up brand loyalty and convince people to ask for the latest 'n greatest still on patent drugs rather than the generic alternatives that were state of the art a decade ago, or even to prefer the more expensive original drug rather than the generic once it's off patent. But this is a problem that's exacerbated by the insurance structure-- if both have the same $20 co-pay, patients are going to go for the name brand, and it's going to be difficult to set up the system so that doesn't happen.

Permalink to Comment

8. John Thacker on January 28, 2008 2:34 PM writes...

Yes, but how does this play out with regard to pharmaceutical marketing deregulation?

Nearly irrelevant. Marketing is designed to increase profits; it's supposed to be a profitable business unit. That's why you see the greatest number of ads for "lifestyle" problems where treatment is optional, or where people don't know that there are treatment options or might not want to mention the problem or think that it's a standard part of getting older. No one advertises for AIDS drugs or chemotherapy (except as part of a "look at how noble our company is" PR). It's absurd to claim, straight up, that money going to marketing is somehow "taken" from R&D. Of course you can argue that the pharmaceuticals are making less profit than they would if they would advertise less.

A somewhat more sophisticated argument is that one that pharmaceutical drug advertising is some kind of tragedy of the commons where the companies are essentially spending money to grab bigger slices of the same pie. However, this contradicts the other common claim, made by milkshake about that "there is not much competitive pressure to keep the prices of new drugs low." If there's a bunch of me too drugs fighting with advertising over the same pie for some condition, then that means that there *is* competitive pressure.

The other complaint about advertising, and probably the strongest one in my mind, is that it's an attempt to build up brand loyalty and convince people to ask for the latest 'n greatest still on patent drugs rather than the generic alternatives that were state of the art a decade ago, or even to prefer the more expensive original drug rather than the generic once it's off patent. But this is a problem that's exacerbated by the insurance structure-- if both have the same $20 co-pay, patients are going to go for the name brand, and it's going to be difficult to set up the system so that doesn't happen.

The insurance structure is the reason that so much marketing expenditure is aimed at doctors, anyway.

Permalink to Comment

9. Palo on January 28, 2008 5:26 PM writes...

The problem is that Europe's propensity for socialist "solutions" - and American tolerance for them

Should we invade Europe?

Permalink to Comment

10. milkshake on January 28, 2008 6:32 PM writes...

we did already, in 1944 - but since then they are allowed their home rule (unless they write in cyrilics - in which case we can bomb them)

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11. arrr on January 28, 2008 7:21 PM writes...

Palo: No, but there are certainly questions as to whether government "negotiation" (which, of course, equates to "we'll pay you X amount or we'll use compulsory licensing") violates the spirit of free trade agreements. If the EU orders Microsoft to sell Windows for 10 bucks a copy to the government or lose the copyright, that would certainly not be tolerated, yet it seems perfectly kosher for drugs. If we ever get tired of subsidizing the world's drug R&D, it would certainly be a valid issue to raise.

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12. anon on January 28, 2008 8:29 PM writes...

"we did already, in 1944"

I learned in history class that we were invited, and came later than we should have, at that.

But then it was a history class taught in the U.S., so I'm sure my imperialist pig teacher got it wrong.

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13. SRC on January 28, 2008 9:35 PM writes...

Maybe we need a drug for stupidity. Huge market, no question about that.

Permalink to Comment

14. Petros on January 29, 2008 2:50 AM writes...

But there are other pricing quriks too.

In Japan price cuts are imposed on all drugs on a biennial basis but the US sees all companies increasing prices of many marketed patented drugs annually (or is it more frequently?). What is the egeneral justification for such policies?

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