Top-down government efforts to corral drug prices will fail

Americans pay a lot for pharmaceuticals, and politicians of all stripes are offering prescription drug price-relief proposals to force prices downward. Top-down approaches, though, carry a high chance of failure. We can get an inkling as to why by looking back at Roman history and surveying the contemporary landscape more closely. 

In 301 AD, Roman Emperor Diocletian blamed inflation on greedy merchants. His “Edict on Maximum Prices” commanded them to lower prices and imposed the death penalty for sellers — and even buyers — who violated it. Despite the brutal power of the crown, the edict was largely ignored. Inflation rolled onward. 

{mosads}The underlying cause was not the greed of merchants, but rather the debasement of money. In such an environment, merchants could either raise prices (and risk death) or lose their tunics. Supply and demand resist even the strongest political forces.

Today’s drug-price debate echoes the complaints and prescriptions of fourth-century Rome. High prices, we hear, are the fault of greedy drug companies; the cure is the mighty fist of government pounding prices downward. 

Some imagine hard-nosed government negotiators bringing drug merchants to heel. Others look to importing cheaper drugs from overseas or tying American prices to foreign prices by law.

From a public-relations standpoint, drug companies are often their own worst enemies. Occasionally, a breathtakingly awful company taints the image of the whole industry. But drug companies are as bound by supply and demand conditions as were Roman merchants. 

Consider some basic factors:

First, the peculiar financial structure of drug manufacturing skews its popular perception. A company may charge thousands of dollars for a dosage that costs pennies or dollars to manufacture.

But that astronomical price incorporates the massive up-front costs of testing and gaining Food and Drug Administration (FDA) approval. The often erratic and unpredictable process can take 15 years and $1.5 billion. Most prospective drugs never make it to market. That’s much of what you’re paying for.

Second, despite popular perception, drug manufacturers are only middle-of-the-road among American industries in terms of profitability. Employ blunt price controls, and you’ll likely cut industry profitability, drive investors away, and discourage development of new drugs. We caught a glimpse of this when liability costs threatened to eradicate America’s vaccine industry.

Third, a good bit of the perception of rapidly rising drug costs derives from changes in the market itself. In the past, a typical drug might serve millions of patients, with $1.5 billion in up-front costs spread across that huge population.

Many of today’s cutting-edge drugs serve tiny patient cohorts. Dividing that $1.5 billion across 1,000 or 10,000 patients is very different. 

Fourth, lower drugs prices in Canada and Europe don’t necessarily reflect the great skills and power of government negotiators. They reflect a concept found in every Econ 101 text: When different consumer populations — like drug buyers in the U.S. and Canada — cannot trade with one another, it’s in both the seller’s and society’s interests to charge different prices to different groups.

Americans are richer than Canadians or Europeans. We are also more demanding — we want the latest and best medications, and we want them today. In such circumstances, it’s unsurprising that we pay more. 

Fifth, allowing Americans to import drugs is unlikely to dent the costs here very much. Once the upfront development costs are spent, manufacturing a dose of medicine can be pretty cheap.

The company can sell the drugs inexpensively to less affluent, less-demanding countries because the companies recoup their costs via higher prices in the U.S. Allow foreigners to sell those drugs back to us, and manufacturers will have no choice other than to raise non-U.S. prices to near our levels.

That means fewer foreigners getting the drugs, lower profits for U.S. manufacturers, less investment in new drugs, and very little change for American consumers. The same sort of scenario is likely to play out with schemes to index American prices to those in other countries. 

{mossecondads}Sixth, the idea that federal government negotiators will hard-bargain the prices down misses an important problem concerning motives. If a Health and Human Services negotiator sits down with a drug company, he may be bargaining with a much higher-paid employee of a prospective future employer.

Award the company a high price today and, when he sends that company a résumé and application a year from now, they’ll remember him fondly. See the Defense Department for examples of how this works. 

We can lower costs, and it requires us to reduce those $1.5 billion in up-front costs. The biggest key likely lies in a speedier, less costly, more predictable FDA process. Achieving that, however, will require a long, concerted effort and some tough political decisions. Much tougher than placing faith in simple, quick solutions.

Robert Graboyes is a senior research fellow with the Mercatus Center at George Mason University.