Arnold Kling  

Drug Companies and Rent-Seeking

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I discuss a suggestion that pharmaceutical companies should be treated like public utilities.


Angell is accusing pharmaceutical companies of what economists call "rent-seeking," which Gordon Tullock defines as "special interest coalitions lobbying the government to transfer wealth to them." Her diagnosis is certainly correct. However, her prescription is the opposite of what economists would recommend...

Marcia Angell is outraged that pharmaceutical companies earn profits and use advertising to encourage people to use their products. To her, these are evil forms of incentives.

However, the alternative to using profits and advertising is to use taxes and regulation. Those are even more coercive forms of incentives. I can choose not to buy pharmaceuticals, but taxes are unavoidable. I can ignore drug company advertising, but I cannot ignore government regulation.


For Discussion. Can you explain to a non-economist why drug research and development efforts would not be increased by eliminating profits and advertising expenditures?


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TRACKBACKS (3 to date)
TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/109
The author at In the Pipeline in a related article titled I'll Have the Price They're Having writes:
    Thanks to Arnold Kling, I found this piece on the economics of the drug industry. It comes from the remarks at a recent industry conference, and it's worth reading (even if it does make an approving reference to Martha Angell... [Tracked on August 24, 2004 6:11 AM]
COMMENTS (19 to date)
Mcwop writes:

I have told this story here before. I have a lifelong condition that requires daily meds. There used to be a generic that worked great treating my condition (i have been through about 4 different meds over the past 10 years). The manufacturer ran into production problems. I could not get the drug, and called the company to find out what was going on. They operator was rather nice, and did transfer me to someone that could help. Because this generic earned so little in profits, it was not worth fixing the production problems to manufacture the drug anymore.

This concept is simple- no profits, no drugs. You do not manufacture something at a loss forever.

Mike Everett writes:

I would ask the non-economist to list the countries where drug research and development efforts are happening, and to considering whether free markets correlate with that list.

Lawrance George Lux writes:
Can you explain to a non-economist why drug research and development efforts would not be increased by eliminating profits and advertising expenditures?

I can explain to an Economist why a ban on Drug advertising would allow Doctors the freedom to adopt the most Cost-effective treatments, especially if they were entailed by law to do so. Regulations forbiding Patent rights extensions for cosmetic alterations could also be beneficial.

The previous Poster can also be answered by statement that a law could be passed forcing Drug companies to produce at previous levels any Drug which was making a Profit; said law would also state Production Cost increase had to be proven to increase Product Price, after R&D costs had been repaid. Tax regulation could also be implemented disallowing R&D expense cancellation of tax, if R&D expenses were incurred in finding a replacement Drug for a current Drug which was eighty percent effective in usage. lgl

Lupo writes:

So after we have regualted R & D costs when put a said law to state all of the testing equiptment used to produce this drug must come from the least cost supplier. Soon after we can pass a law that does not allow anything but low flow toilets in research facilities then only compostable toilet paper then....... The endless road to the already over regulated.

Brad Hutchings writes:

Lawrence, that reads like Ayn Rand's descriptions of various regulators in Atlas Shrugged. You're not doing some kind of Phil Hendrie thing on us, are you? <grin>

Arnold, this is a tough question because non-economists don't think like economists. I think you have to relate the incentive thing to control and you need to make the example personal. So this is a rough thought on an approach one might use. Most of us, especially those of us in that elite 85+ IQ range, had experiences growing up where our parents told us to do something or steered us in a direction that they were either wrong about or too controlling, or not in line with what we wanted from our lives. Maybe it was a girlfriend or relative importance of grades, choice of school or academic focus, sports or social activities... I'm not talking about drugs/alcohol where they were right and had a responsibility to step in. But the marginal stuff. And we all know that even the most "enlightened" parents pull this garbage, they're just subtle about it. It causes conflict, hurt feelings, resentment, and ultimately, working around the parent.

Now imagine that you know how to do the research to come up with new drugs. Or you feel very strongly that some portion of your nest egg should be invested in this area because of the good it can do for people. Or you are a highly skilled product or production manager and feel that your talents would best be used to help a company make these processes efficient. If the government is so concerned about how much anyone is profiting in this arena, maybe you take your enthusiasm, skills, and money to different industries or even different countries. You basically tell Mom and Dad something Dick Cheney might say and go your own way. Now what good does that do anyone? Just as parents eventually learn that their kids have their own goals and directions and sometimes make bad decisions as they grow up, governments need to learn the same about drug companies in particular and companies in general. If you interfere, you will drive them away. Drive them away, no drugs.

Ed Snack writes:

McWop, so what are you meaning to say ? That you would willingly pay higher prices for your medication ? Presumably for the product to make too little profit, then either low demand or competition was the problem. If competition was the problem, then there should be alternative suppliers, if no direct competition, then the reason is far more likely to be that the company produces a competing product which generates a much higher margin, at presumably a higher price. If demand exists, and the product is no longer patent protected, then someone will probably make it and sell it at a profit if this can be done.

Don't make the mistake of assuming that drug companies are in it for your health. They have been consisttently one of the most profitable sectors of industry for a considerable period.

DSpears writes:

"Don't make the mistake of assuming that drug companies are in it for your health."

Neither is the government.

Mike Everett writes:

Would lgl care to proof-read this?

"I can explain to an Economist why a ban on Drug advertising would allow Doctors the freedom to adopt the most Cost-effective treatments, especially if they were entailed by law to do so."

OK. Doctors will have more freedom when the law restricts choice.

"said law would also state Production Cost increase had to be proven to increase Product Price"

Oh, sure. No rent-seeking accountant could possibly cook the books to get around this provision.

Lawrance George Lux writes:

It appeals that most here would claim an Libertarian position, yet deny any protection for lack of education and training. Limitation of Drug Company advertising to only medical specialists reduces the Cost and Loss of both Advertising, and of medical mistakes. A law insisting that Drug Companies produce profitable production Drugs grants Consumers far greater choice in my opinion. A law limiting Price-gouging also seems to provide Consumers far greater choice options in the expenditure of their Consumption dollars. Elimination of cosmetic Patent-holding claims would invariably reduce Consumer Costs, thereby giving greater Consumer choice. Where are my real Libertarians? lgl

Walker writes:

lgl, if being a libertarian meant trying to craft government regulations so as to benefit the consumer, then count Ralph Nader among the ranks.

Alex writes:

Agree with LG Lux.

Bernard Yomtov writes:

Not sure I understand your point, Arnold.

Would you favor doing away with patent protection, for example, in order to move us closer to a true free market in pharmaceuticals?

Would you favor requiring the drug companies to pay royalties to the government for use of government-funded research?

Or are these rents OK for some reason?

I also don't think your physician analogy quite holds. It's true that access to the profession is restricted, but individual physicians do not have monopolies on treatments. Any surgeon can take out an appendix.

Dez Akin writes:

I think this particulary commentary is a bit slavish to ideology without actually examining the issues closely. This deals with the government providing limited monopoly in the interest of furthering innovation, so we've allready crossed a libertarian threshhold.

Markets certainly work for commodities that are transparent, so the real challenge here is to turn the pharmacudical industry into a transparent market; which today it certainly isn't. Consumers know little about comparisons between one product and another, and pharmacorps profit on the lack of knowledge in brand building.

The classic example is proton pump inhibitors. They all work relatively the same, with almost no difference, but the one you've probably heard the most about is Esomeprazole, or in the adds, Nexium. Since its still under patent, the drug company does direct consumer marketing of it to convince potential consumers that their symptoms are best treated by said new product:

A line you've probably heard is: "Its different for people with acid reflux disease" or chronic heartburn. Generic omeprazole behaves nearly exactly the same as Nexium.

Most people don't have access to this information, and what is needed is to force markets to behave more transparently. There seems to be a refrain that regulation is bad for markets, ignoring that without any regulation, markets devolve into oligarchies and monopolies.

Particularly necissary is ensuring that the doctors are educated by an objective third party with no interest in fixing the game.

This argument has been detailed in Frontline's analysis of The other drug war.

DSpears writes:

"Most people don't have access to this information, and what is needed is to force markets to behave more transparently. "

The last time I checked, people don't prescribe their own drugs to themselves. That's what their doctors are for. Of course it's a free country and people can shop for a doctor that will prescribe the medicine they want. I guess that's a bad thing??

Tim writes:

I think that most people who have studied economics would agree that advertising, when applied to monopolistically competitive and oligopolistic models, has the effect of increasing both demand and the quantity demanded, while causing an increase in price due to the new cost schedule of the firm. Having family friends who are GPs and work in doctors' offices, I have become aware of the incredible amount of money and waste that drugs companies spend on trying to push their products, including useless merchandise. A possible solution to minimising the cost of drug companies disseminating information while making doctors aware of the new products is to establish a statutory authority or other government agency that periodically accepts submissions from drug companies regarding their products and compiles and presents it in a way that is easy for doctors to understand and prevent bias or leverage of a dominant marketing position. By doing this and preventing direct marketing I think a better system of drug admisitration would be possible. It eliminates the distortions and waste of advertising (although I appreciate their is a cost in the regulation of the information and production of submissions, I cannot see how they could equal or exceed that of the large PR campaigns) and doesn't create a function that is excessively regulatory.
my 2 cents
tim

ds writes:

"Having family friends who are GPs and work in doctors' offices, I have become aware of the incredible amount of money and waste that drugs companies spend on trying to push their products, including useless merchandise. "

What do you mean by "waste"?

Advertising in any industry can be used to make consumers aware of new products on the market. I hardly see that as a bad thing. The way the system works is that doctors are aligned (i.e., paid), sometimes exclusively, with certain drug companies and generally tend to prescribe those drugs exclusively (your GP acquaintances may not admit to this but it's how things are done in the healthcare industry). They all do it, nobody is holier than anybody else in this regard. The drug companies use direct advertising to force consumers to ask their doctor questions about other medications that may replace the ones made by their competitors. That's called competition.

The patients have the right to this information and limiting this sort of exposure would be a travesty. It would perpetuate the staus quo, reduce competition (which what is really missing form the healthcare market) and ultimately keep costs higher than they otehrwise would be.

"A possible solution to minimising the cost of drug companies disseminating information while making doctors aware of the new products is to establish a statutory authority or other government agency that periodically accepts submissions from drug companies regarding their products and compiles and presents it in a way that is easy for doctors to understand and prevent bias or leverage of a dominant marketing position."

We already have that, it's called the FDA. I think it's safe to say that the existence of that agency does not lower healthcare costs in any way. Probably just the opposite.

Ultimately the choice of drugs should be made between the doctor and the patient. The doctors don't like drug company advertising because it makes for more informed patients, who can be a real pain in the neck. Is that bad? Shouldn't patients have MORE information available to them to make good decisions, not less?

Lawrance George Lux writes:

ds,
Your comment about the FDA is quite accurate. It is the problems created by Drugs and other Products approved by the FDA which are the worst Costs in the health care industry. Effective studies not taken by the FDA would state more than three-quarters of the nureological damage caused to AIDS victims is incited by the Drugs inflicted on them by a Rent-seeking health care structure. lgl

Jon writes:

Part of the debate over healthcare and drugs arises because of a conflict between the effectiveness of free enterprise in rationing goods and the interest in most of our society in providing some form of healthcare regardless of ability to pay.

Most people in the US would disapprove a policy that says "if you cannot afford the treatment we will let you suffer or die". In fact most are probably bothered by a policy that even says you go bankrupt if you get very sick and cannot afford the treatment.

Hence we end up with a hodgepodge system in which providers can offer services and pharmaceuticals and the people making the purchasing decisions do not pay for most of the cost. When people have to fork over the cost of the drugs, they conserve, though less wealthy do often to the point of wrecking their health.

jjj writes:

part of the problem is that the doctor's making the decision of which medicine to prescribe have no direct incentive to make sure it is cost-effective.

the doctor is trying to help the patient and if the scientific literature shows that one drug works better than another (even marginally) most doctors will prescribe the more effective drug (you can also replace more effictive with safer, better dosing schedule, etc.)

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