Arnold Kling  

Drug Price Controls

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Some economists published a petition against drug price controls.

Drug-price controls are more difficult to remove than other price controls. Controls on oil and other products often tend to be limited or short-lived, as voters eventually object to the resulting shortages and distortions. The effects of drug price controls, however, are far more difficult to observe because they mainly affect medicines that haven't been invented yet.

UPDATE: for a more emotional take on the issue, see Derek Lowe.

For Discussion. Is the threat of drug price controls sufficient to reduce investment in new drug discovery?

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CATEGORIES: Price Controls

COMMENTS (11 to date)
Andrew writes:

I think it's bad to have two systems interfering in the market in opposite directions. The patent system is designed to encourage research by giving monopolies, pushing the price up, and price controls reduce the price, discouraging research. It would be better to replace price controls with a weakening of the patent system, either in the form of reduced terms or by compulsory licensing.
There is no "general principle" that can answer where the balance should be -- patents are a pragmatic device to balance interests which have to be responsive to detailed studies of their effects.

Joe Kristan writes:

"For Discussion. Is the threat of drug price controls sufficient to reduce investment in new drug discovery?"

Well, I wonder how many students would study, say, accounting, if they knew that accounting salaries would be capped at a "fair" number - say $60,000 per year. Not many, and not the smartest ones, I'd wager.

I can't see why R&D investment would be different.

Boonton writes:

How about this modification of the patent system:

To obtain a patent a drug company must name a price that they would agree to accept for the drug to be sent to the public domain. The patent fee would be based on this price and would be hefty.

Should the gov't or a public interest group raise the funds to pay this price, the patent will fall to the public domain allowing the drug to be produced at cost by anyone.

The price will be reasonable because if drug companies name a price that is too high, they will pay in excessive patent fees. If they name a price that is too low the patent will get brought out under them.

The additional patent fees could be put into a fund to finance the purchase of 'essential patents' in the interest of keeping needed drugs affordable.

Boonton writes:

An example:

J&J develops a new AIDS drug and a new cosmetic drug. They value the AIDS drug at $250M and the cosmetic drug at $750M. The patent fee is 10% so they pay $25M for the AIDS drug and $75M for the cosmetic drug.

The gov't drug fund has $100M, suppose private charities & other groups raise $150M. Combined they pay J&J the $250M & the drug is now off patent. J&J will recoup its R&D costs for the AIDS drug while it is also able to sell its cosmetic drug with the benefit of patents.

Suppose J&J hated the idea of having its patents brought out from under them? Say they declare the value of their drugs at $5 Billion. All they would accomplish is forcing themselves to pay $500M into the fund which will be used to lower the price of drugs.

Lawrance George Lux writes:

Boonton's idea shows promise. One concept I was working on was to issue the Patent with stated royalty, based upon Cost of Development and total estimated usage of the Product. The Patented Product would be in the Public Domain, and Anyone could produce the Product, simply by paying the royalties.

Patent life would be extended to a financial value worth five times the Cost of Development; if such an amount is ever reached. lgl

Bernard Yomtov writes:

Are you asking whether the threat by itself is sufficient, in the absence of actual controls?

I would say that the possibility of price controls is always present in the pharmaceutical business, and so may already have some influence on decisions.

Dave Sheridan writes:

"For Discussion. Is the threat of drug price controls sufficient to reduce investment in new drug discovery?"

The short answer, sure it is. Even the threat of price controls affects capital budgeting decisions. Evaluating the allocation of capital to new drug research includes:
- expected cost of the research program
- probability of success in getting product to market (a long shot, but estimates must be made)
- estimated economic return to a marketable product

Estimates of the return obviously factor in pricing potential. Decisions by firms to undertake new research will be affected by the firms' estimates of pricing conditions at the end of the development pipeline, possibly several years into the future. Current controls and concessions are certainly already incorporated into planning models. Firms will change their pricing assumptions as political conditions suggest that they need to be changed. In the limit, where price controls cover only the marginal costs of production (as some politicians advocate,) then essentially no new drug resarch will occur.

Since no one wants this outcome, the question for advocates of price controls, as boonton addresses above, should boil down to how to compensate pharmaceutical firms for the value of their intellectual property. I'm pretty much a free market militant on this and so haven't seen any mechanism seriously discussed that addresses this problem effectively.

triticale writes:

It was, IHMO, the threat of price controls which brought the nonsense of rebates to US marketing practice. Nixon was talking price control, so big-ticket manufacturers, most notably the auto companies, raised the declared price of their product and then rebated back the effective selling price. When costs went up despite the price freeze, they could drop the rebate and claim not to be illegally raising the price.

As luck would have it, consumers percieved the rebate as saving them money, and so the practice survived longer than the threat of price controls. I'm just offering this as evidence that such threats effect marketing practice and could thus effect R&D investment by pharmacuetical companies.

Boonton writes:

The argument that price controls may inhibit R&D is valid, but what is missed is that drugs are not produced in a market environment. Drug companies have a artificial gov't enforced monopoly.

The justification for this is that the monopoly fosters innovation, but like all monopolies it makes basic production of the good more expensive and inefficient. How do you balance the harm caused by a gov't set monopoly with the good of new drugs? (Related to this is whether there is too much R&D going into drugs, already there has been some news that many companies have fewer new drugs in their pipelines despite dramatically increasing their R& do we know we wouldn't get more bang for the buck if 20% of R&D budgets was invested in basic healthcare or educating people on living healthier etc.)

So the market is not really determine how much to invest in R&D because the gov't is distorting it with its monopoly policy. I think my proposal attempts to correct this by introducing something of a market to the monopoly, making people think about how much the monopoly is worth versus allowing free enterprise in producing drugs.

Considering that gov't policy is for a monopoly on new drugs, how should the monopoly be balanced against a free market? If you think about it, the balance right now is being set by gov't regulators.

Dave Sheridan writes:

Boonton: You're exactly right. Patents, trademarks and copyrights are government grants of temporary monopoly, so government gets to set the terms. Currently, firms are free to license patents for whatever price they can negotiate, without the need for a pool. Your patent transfer proposal is simply the sale of an unlimited-rights license for a one-time fee. Companies can negotiate those now. The issue is whether, after the fact (after an innovation has been created), governments can step in and arbitrarily set a price that is lower than what the company wishes to charge. That is at the heart of the drug issue vis-a-vis Canada, where the Canadian government(National or Provincial) asserts that it can break a patent and assign a licensing fee lower than what the company is willing to charge, unless the company agrees to the government's purchase price.

Boonton writes:

"Your patent transfer proposal is simply the sale of an unlimited-rights license for a one-time fee. Companies can negotiate those now. "

But it also tries to impose a market price on monopoly. The more monopoly demanded (by demanding a higher price to part with their patents) results in higher fees paid to the 'common pool' that can be used to fund either 'open source' medicine, additional R&D or coverage for those who can't afford it.

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